CPA TCP: Entity Tax Planning

CPA means Certified Public Accountant. TCP means Tax Compliance and Planning. Use this focused page when your CPA TCP misses are about entity choice, elections, owner compensation, distributions, cash-flow trade-offs, or after-tax planning consequences. Drill this topic before returning to mixed practice.

Topic snapshot

What this topic tests

This topic tests planning judgment rather than only compliance mechanics. Strong answers consider entity choice, owner compensation, distributions, elections, timing, cash flow, liability, and after-tax consequences.

Common traps

• choosing the lowest immediate tax answer without considering later owner-level effects
• ignoring payroll, self-employment, reasonable compensation, or distribution constraints
• treating an election as beneficial without checking eligibility and timing
• giving a planning answer that conflicts with cash-flow, risk, or compliance facts in the stem

How to reason through these questions

Frame the issue as a planning trade-off: current tax, future tax, cash flow, owner basis, administrative burden, and risk. If an answer optimizes one variable while ignoring the stated client objective, it is usually too narrow.

Sample questions

These questions are original Mastery Exam Prep practice items aligned to this topic area. They are designed for self-assessment and are not official exam questions.

Question 1

Topic: Entity Tax Planning

Two U.S. individual founders will each hold 50% voting control of a new consulting business. Their stated objectives are:

• limited liability for both owners
• single-level taxation
• 80% of startup tax losses to Mia for the first 2 years because she will contribute $400,000 cash, while Leo will contribute $100,000 cash
• future cash distributions based on each owner’s tax liability and business cash needs rather than strictly by ownership percentage

A staff memo concludes: “Form an S corporation. It will provide limited liability, pass-through taxation, and enough flexibility to allocate early losses 80/20 and make nonpro rata cash distributions through a shareholder agreement.”

Which response is the best correction to the memo?

• A. Revise the recommendation to an LLC taxed as a partnership, because it can provide limited liability and pass-through taxation while allowing special allocations and flexible distribution provisions if properly drafted under partnership tax rules.
• B. Keep the S corporation recommendation, but authorize voting and nonvoting shares so the owners can vary loss allocations and cash distributions without affecting S status.
• C. Change the recommendation to a C corporation, because corporate law allows owners to customize economic rights more freely than a pass-through entity.
• D. Keep the S corporation recommendation, but state that a unanimous shareholder agreement can override the pro rata allocation and distribution rules.

Best answer: A

What this tests: Entity Tax Planning

Explanation: The memo is incorrect because an S corporation does not permit special allocations of income or loss or nonpro rata distributions. An LLC taxed as a partnership better fits the stated legal, tax, ownership-control, and cash-flow objectives if its operating agreement is drafted to satisfy partnership tax rules.

This formation decision turns on the owners’ requested economics. Both an S corporation and an LLC can provide limited liability and single-level taxation, but only one of them generally supports the flexibility described. An S corporation must maintain a single class of stock for economic rights, so income, loss, and distributions generally follow ownership interests rather than custom 80/20 allocations or need-based cash distributions. A shareholder agreement cannot override that tax result. An LLC taxed as a partnership can preserve limited liability and pass-through treatment while also allowing special allocations and tax-distribution provisions if the agreement is properly drafted and the allocations are respected under partnership tax principles. Because the founders want equal control but unequal tax-loss sharing and flexible cash distributions, the correct adjustment is to replace the S corporation recommendation with an LLC taxed as a partnership.

• The LLC taxed as a partnership is the best correction because it aligns with limited liability, pass-through taxation, and flexible economic arrangements.
• Voting and nonvoting stock in an S corporation can vary control rights, but not the underlying economic rights needed for 80/20 losses and nonpro rata distributions.
• A C corporation may offer legal flexibility, but it does not satisfy the stated single-level taxation objective and does not pass tax losses through to owners.
• Owner consent does not let an S corporation bypass the pro rata economic rules required to preserve S status.

An S corporation cannot validly provide the requested 80/20 loss allocations and nonpro rata cash distributions, but an LLC taxed as a partnership can be structured to do so while preserving limited liability and pass-through treatment.

Question 2

Topic: Entity Tax Planning

Redwood, Inc., a calendar-year C corporation, plans a year-end nonliquidating distribution of land to its sole shareholder, Mia.

Assume the mortgage does not exceed the land’s FMV, the corporation’s recognized gain is fully reflected in E&P, and corporate-level income tax effects are ignored. Which is the best interpretation of the federal income tax consequences of the distribution?

• A. Redwood recognizes $120,000 gain; Mia receives a $190,000 dividend; Mia’s basis in the land is $160,000.
• B. Redwood recognizes no gain; Mia receives a $160,000 dividend; Mia’s basis in the land is $70,000.
• C. Redwood recognizes $120,000 gain; Mia receives a $160,000 dividend; Mia’s basis in the land is $190,000.
• D. Redwood recognizes $120,000 gain; Mia first reduces her $90,000 stock basis and then recognizes capital gain on the excess; Mia’s basis in the land is $70,000.

Best answer: C

What this tests: Entity Tax Planning

Explanation: A C corporation recognizes gain when it distributes appreciated property in a nonliquidating distribution. Mia’s distribution amount is the land’s FMV reduced by the mortgage she assumes, and because Redwood has sufficient E&P, the full $160,000 is dividend income. Mia’s basis in the land is its $190,000 FMV.

When a C corporation makes a nonliquidating distribution of appreciated property, it is treated as if it sold the property for FMV. Redwood therefore recognizes $120,000 of corporate gain ($190,000 FMV less $70,000 basis). For Mia, the amount of the distribution is the FMV of the land reduced by the liability she assumes, so her distribution amount is $160,000 ($190,000 less $30,000). A property distribution is taxed as a dividend to the extent of the corporation’s current and accumulated E&P. Redwood has more than enough E&P, so the full $160,000 is dividend income; Mia does not recover stock basis first. Stock basis matters only after E&P is exhausted. The basis of property received in this type of distribution is FMV, so Mia takes a $190,000 basis in the land.

• Treating the land transfer as creating no corporate gain ignores the rule for appreciated property distributions by a C corporation.
• Using $190,000 as Mia’s dividend ignores the mortgage she assumes; the liability reduces the amount of the distribution to $160,000.
• Applying Mia’s stock basis first is wrong because basis recovery occurs only after E&P is exhausted.
• Giving Mia a carryover basis or a net-of-liability basis in the land is incorrect; her basis is the land’s FMV at distribution.

An appreciated property distribution triggers corporate gain equal to FMV minus basis, the shareholder’s distribution amount is FMV less the assumed liability, and with sufficient E&P that amount is dividend income while the property’s basis is FMV.

Question 3

Topic: Entity Tax Planning

Jordan and Priya plan to launch a design business on January 1. Their attorney proposed forming an LLC owned 50/50 and leaving it taxed as a partnership.

Current facts:

• Both want limited liability.
• Jordan would contribute equipment with a $180,000 FMV, $60,000 tax basis, and a $40,000 loan that the new entity would assume.
• Priya would contribute $140,000 cash and work full time in the business.
• Jordan wants any early losses, if allowable, to help offset other income.
• Priya expects regular cash withdrawals for living expenses.
• They have not decided how profits, losses, or cash distributions would be allocated, and no projections have been prepared.

Which of the following is the most appropriate next step for the CPA to determine whether the proposed formation plan fits their objectives?

• A. Prepare the LLC operating agreement immediately with equal allocations because the 50/50 ownership split has already been proposed.
• B. Recommend an immediate S corporation election because paying the working owner a salary will usually improve tax efficiency.
• C. Focus first on confirming state-law liability protection because tax consequences can be refined after formation.
• D. Obtain owner-by-owner projections for contributions, liability sharing, expected loss use, and compensation or distribution needs, then compare whether the proposed structure fits those objectives.

Best answer: D

What this tests: Entity Tax Planning

Explanation: The best next step is to gather the missing owner-level inputs and model the proposed formation structure against the owners’ actual tax and cash-flow goals. A legal form or tax election should not be finalized before analyzing contributions, debt, loss expectations, and planned distributions.

In entity formation planning, the CPA should first collect the schedule inputs that drive whether the structure fits the owners’ objectives. Here, Jordan’s appreciated property and debt assumption, Jordan’s desire to use early losses, and Priya’s need for regular cash withdrawals all have owner-level tax and economic effects that must be analyzed before confirming an LLC taxed as a partnership or recommending another form. Limited liability alone does not answer the tax and cash-flow questions because more than one legal structure can provide that protection. The proper next step is to build owner-by-owner projections for contributions, liabilities, allocations, and cash needs, then compare the proposed formation plan to those goals before drafting documents or making elections.

• Preparing the LLC agreement immediately is premature because the allocation and distribution terms have not yet been tested against the owners’ tax and cash-flow goals.
• Recommending an S corporation election skips the required analysis; possible payroll tax benefits do not automatically outweigh other formation and owner-level consequences.
• Focusing only on liability protection addresses just one objective and ignores the tax, ownership, and cash-flow fit that the CPA must evaluate.

Formation planning should begin with complete owner-level tax and economic data before confirming an entity choice or drafting final terms.

Question 4

Topic: Entity Tax Planning

Maria will be the sole owner of a new domestic design firm and is eligible to elect S corporation status. She will materially participate, expects consistent taxable income, and will pay herself reasonable W-2 compensation under either a C corporation or S corporation structure. After paying salary and operating costs, she expects most remaining earnings to be paid out to herself each year rather than retained for expansion. In comparing the federal tax consequences of the entity choice, which input should be characterized as the most direct tax-sensitive planning input?

• A. Expected number of first-year administrative employees
• B. Expected method of acquiring business equipment
• C. Expected policy for distributing or retaining post-salary earnings
• D. Expected tax accounting method for operations

Best answer: C

What this tests: Entity Tax Planning

Explanation: The key input is whether earnings will be distributed or retained after reasonable compensation is paid. Under a C corporation, distributed earnings can create a second tax at the shareholder level, while an S corporation generally passes income through once.

For a closely held profitable business comparing C corporation and S corporation status, a major planning input is the expected treatment of earnings after paying reasonable compensation. A C corporation is taxed at the entity level, and later distributions of after-tax earnings may be taxed again to the shareholder as dividends. An S corporation generally passes taxable income through to the shareholder currently, and distributions usually are not taxed again to the extent of basis. Because Maria expects to distribute most remaining earnings each year, the distribution-versus-retention assumption is the most direct driver of the comparative federal tax result. The other inputs may affect deductions, timing, or operations, but they do not usually determine whether the business is exposed to one level of tax or potential double taxation.

• The expected method of acquiring equipment can affect deductions and cash flow, but it does not usually drive the core C-versus-S comparison as directly as dividend or retention policy.
• The expected tax accounting method affects timing of income and deductions, but both entity types can be affected by accounting method rules.
• The expected number of employees may change payroll and operating costs, but it does not directly determine whether post-tax business earnings face one tax layer or two.

Distribution versus retention of post-salary earnings most directly affects whether C corporation profits may face a second shareholder-level tax, unlike S corporation pass-through income.

Question 5

Topic: Entity Tax Planning

Maple Ridge LLC, taxed as a partnership, has two equal partners, Lana and Milo.

Additional facts:

• After the guaranteed payment, all remaining ordinary business income is allocated 50% to each partner.
• No liabilities, separately stated items, or other basis adjustments apply.

Which statement is the best interpretation of Lana’s 2025 federal income tax consequences?

• A. She reports $72,000 of ordinary income, consisting of the $24,000 guaranteed payment plus $48,000 as her share of the remaining partnership income, and she recognizes no gain on the $18,000 nonliquidating cash distribution.
• B. She reports $48,000 of ordinary income because only her share of post-guaranteed-payment partnership income is taxable, and the guaranteed payment is treated as a tax-free draw.
• C. She reports $72,000 of ordinary income and $18,000 of capital gain because a nonliquidating cash distribution is always taxable when received.
• D. She reports $60,000 of ordinary income because the guaranteed payment is treated as part of her 50% distributive share, and she recognizes no gain on the cash distribution.

Best answer: A

What this tests: Entity Tax Planning

Explanation: Lana must include the guaranteed payment in ordinary income separately from her distributive share. The partnership’s remaining ordinary income after the guaranteed payment is $96,000, so Lana’s 50% share is $48,000; with the $24,000 guaranteed payment, her total ordinary income is $72,000, and the $18,000 cash distribution does not trigger gain because it does not exceed her outside basis.

A guaranteed payment to a partner for services is taxed as ordinary income to that partner and is taken into account before allocating the partnership’s remaining ordinary business income. Here, Maple Ridge starts with $120,000 of ordinary business income, deducts the $24,000 guaranteed payment, and has $96,000 left to allocate. Lana receives 50% of that amount, or $48,000, plus the $24,000 guaranteed payment, for total ordinary income of $72,000.

The nonliquidating cash distribution is analyzed separately. Cash distributed in a nonliquidating distribution generally does not cause immediate gain unless the cash exceeds the partner’s outside basis. Because Lana’s basis is sufficient, the $18,000 cash distribution is not currently taxable; it simply reduces outside basis.

• Treating the guaranteed payment as merely part of Lana’s 50% share ignores that it is separately taxable to her and deducted before the remaining income is split.
• Taxing only the $48,000 post-guaranteed-payment allocation wrongly treats the guaranteed payment as a nontaxable draw; guaranteed payments are ordinary income.
• Treating the $18,000 cash distribution as automatically taxable ignores the nonliquidating distribution rule that gain arises only if cash exceeds outside basis.

Guaranteed payments are ordinary income to the recipient partner and reduce partnership ordinary income before the remaining income is allocated, while a nonliquidating cash distribution is tax-free unless it exceeds outside basis.

Question 6

Topic: Entity Tax Planning

Blue Ridge, Inc. was a C corporation until its S election became effective on January 1, 2024. The corporation is still within the built-in gains recognition period in 2026.

Management wants to sell one asset on September 30, 2026, to raise cash and asks its CPA which sale would minimize corporate built-in gains tax. Assume no selling expenses, no NOL carryovers, and the taxable income limitation will not reduce recognized built-in gain.

What should the CPA do next?

• A. Recommend distributing the land to the shareholders before any sale, because a shareholder sale avoids the S corporation’s corporate-level built-in gains tax.
• B. Prepare a recognized built-in gain schedule using the lesser of the gain built in on 1/1/24 or the projected gain on sale; the amounts are land $180,000, equipment $90,000, and customer list $95,000, so the equipment sale best minimizes built-in gains tax.
• C. Project built-in gains using only the expected gain on the 2026 sale date and recommend the asset with the lowest current gain, because the 1/1/24 values are no longer relevant once the S election is in effect.
• D. First compute each shareholder’s stock basis and distribution tax effects, because shareholder-level consequences determine which asset disposition minimizes the built-in gains tax.

Best answer: B

What this tests: Entity Tax Planning

Explanation: The next step is to compute recognized built-in gain asset by asset using the lesser-of rule. Here, the projected amounts subject to built-in gains tax are land $180,000, equipment $90,000, and customer list $95,000, so selling the equipment best minimizes the tax exposure.

For an S corporation that previously operated as a C corporation, built-in gains tax can apply to gains recognized during the recognition period. For each asset, the projected amount subject to the tax is generally the lesser of (1) the built-in gain that existed on the S-election effective date and (2) the gain actually recognized when the asset is sold. Applying that rule here: land had $180,000 of built-in gain on 1/1/24 and would produce $190,000 of current gain, so $180,000 is subject to the tax; equipment had $90,000 of built-in gain and would produce $90,000 of current gain, so $90,000 is subject to the tax; the customer list had $150,000 of built-in gain but would produce only $95,000 of current gain, so $95,000 is subject to the tax. Because the taxable income limitation is assumed not to apply, the equipment sale gives the smallest built-in gains amount.

• Using only the 2026 sale-date gain skips the required comparison to the gain built in on the S-election date.
• Computing shareholder stock basis is a different analysis and does not determine the corporation’s built-in gains tax exposure.
• Distributing appreciated property before sale does not avoid the corporate-level built-in gain issue and is not the proper planning step here.

During the recognition period, recognized built-in gain for each asset is limited to the lesser of conversion-date built-in gain or actual gain on disposition, making the equipment sale the lowest built-in gains exposure.

Question 7

Topic: Entity Tax Planning

Harborline, Inc. is an S corporation.

Facts:

• Olivia and Noah each own 50% of Harborline’s outstanding common stock.
• Harborline needs $300,000 to fund an expansion.
• Olivia is willing to provide all $300,000.
• Olivia wants a fixed 8% annual return and full repayment in 3 years.
• Noah wants stock ownership to remain 50/50.
• The shareholders want to preserve Harborline’s S election.

The CPA concludes that the best planning option is for Olivia to advance the funds as straight debt rather than receive preferred distribution or liquidation rights. Which item of evidence best supports that conclusion?

• A. A revised capitalization table showing Olivia would receive nonvoting preferred shares while Noah would continue to hold only common shares.
• B. An email chain stating that Harborline expects to repay Olivia when cash flow allows, with interest terms to be decided later by the board.
• C. A draft charter amendment giving Olivia the first 8% annual cash distributions and a liquidation preference until her $300,000 is fully recovered.
• D. A signed note from Harborline to Olivia with an unconditional promise to pay $300,000 on a fixed maturity date, fixed interest payments not tied to profits, no conversion right into stock, and normal creditor remedies.

Best answer: D

What this tests: Entity Tax Planning

Explanation: The signed fixed-term note is the best evidence because it shows a bona fide straight-debt arrangement, not equity with preferred economic rights. Proper straight debt can preserve an S corporation’s one-class-of-stock requirement while still giving Olivia a contractual return and repayment schedule.

An S corporation generally may have only one class of stock, and differences in distribution or liquidation rights can create a prohibited second class. A shareholder advance is less likely to threaten the S election when it is structured as straight debt: a written unconditional promise to pay a sum certain on demand or on a specified date, with interest and payment terms not contingent on profits, and no conversion feature into stock. The signed note fits that pattern and directly supports the CPA’s conclusion. By contrast, preferred distribution rights, liquidation preferences, or preferred shares create unequal equity rights among shareholders and can jeopardize the S election. A vague informal promise to repay later is also weak support because it lacks the definite debt terms needed to distinguish debt from equity.

• The charter amendment supports a different conclusion because preferred distribution and liquidation rights can create a second class of stock.
• The email chain is incomplete and unreliable evidence because it lacks fixed repayment and interest terms needed for strong debt support.
• The preferred-share capitalization table directly points to differing equity rights, which is the opposite of preserving the one-class-of-stock rule.

This document supports straight-debt treatment, which can preserve the one-class-of-stock rule while giving Olivia a fixed return and repayment right.

Question 8

Topic: Entity Tax Planning

Lark C Corp, a calendar-year C corporation wholly owned by Priya, is considering a year-end distribution of unimproved land that it acquired several years after formation. A tax manager’s draft memo states:

“If Lark distributes the land, Lark may recognize corporate-level gain, and Priya may be taxed on a dividend to the extent of Lark’s earnings and profits. Priya’s basis in the land would generally be its fair market value on the distribution date.”

Which evidence package best supports that draft memo?

• A. Lark’s cash-flow forecast, bank covenant summary, and projected payroll needs after the distribution
• B. A recent appraisal of the land, the board minutes approving the distribution, and the signed deed transferring title
• C. A recent appraisal of the land, the fixed-asset tax basis schedule for the land, and an earnings-and-profits workpaper showing positive current or accumulated E&P
• D. Priya’s stock basis schedule, her stock acquisition date, and her capital loss carryforward schedule

Best answer: C

What this tests: Entity Tax Planning

Explanation: For a C corporation, distributing appreciated property is generally treated as if the corporation sold the property for fair market value, so the critical corporate evidence is FMV compared with adjusted basis. Shareholder dividend treatment depends on the corporation’s earnings and profits, so the best support includes both basis-versus-FMV data and an E&P workpaper.

A noncash property distribution by a C corporation requires two separate tax analyses. First, at the corporate level, the corporation generally recognizes gain if the property’s fair market value exceeds its adjusted tax basis, as though the property were sold for FMV. Second, at the shareholder level, the distribution is treated under the property distribution rules and is a dividend to the extent of the corporation’s current and accumulated earnings and profits. The shareholder’s basis in the distributed property is generally its fair market value on the distribution date. Because of those rules, the most useful support is evidence showing the property’s adjusted basis, its current FMV, and the corporation’s E&P position. Without those facts, the memo’s conclusions about corporate gain and dividend treatment are not well supported.

• An appraisal, board approval, and a deed help show value and legal transfer, but they do not establish adjusted tax basis or earnings and profits.
• The shareholder’s stock basis, holding period, and personal carryforwards do not determine whether a C corporation’s property distribution is a dividend.
• Cash-flow and loan-covenant records may matter for business feasibility, but they do not support the tax conclusion about gain recognition and dividend treatment.

This package establishes the land’s built-in gain and the corporation’s E&P, which are the key facts for corporate gain recognition and shareholder dividend treatment.

Question 9

Topic: Entity Tax Planning

Jordan, CPA, is helping two founders choose an entity for a new business. They are considering either a C corporation or a multi-member LLC taxed as a partnership.

Additional facts:

• Each founder will receive only equity.
• If a corporation is formed, the corporation will assume the mortgage.
• If an LLC taxed as a partnership is formed, the mortgage will remain nonrecourse and will be allocated 70% to Nora and 30% to Eli.
• No other assets, liabilities, or owners are involved.

Based on these facts, what should Jordan do next to evaluate the formation tax consequences?

• A. Finalize the LLC recommendation by treating the full $90,000 mortgage as taxable cash distributed to Nora on contribution.
• B. Prepare an entity-by-entity formation schedule that computes recognized gain and owner basis, including Nora’s $10,000 corporate gain and her no-current-gain LLC result after 70% debt allocation.
• C. Compare projected annual entity tax rates before reviewing basis and liability schedules, because FMV and debt do not change owner-level formation tax when only equity is issued.
• D. Recommend the corporation immediately because the transferors will control it after the exchange, so no contributor can recognize gain on formation.

Best answer: B

What this tests: Entity Tax Planning

Explanation: The next step is to compute the owner-level formation consequences under each entity choice before making a recommendation. Here, a corporate transfer would create $10,000 of gain because Nora’s assumed liability exceeds her $80,000 basis, while the LLC option would not create current gain because 70% of the debt is allocated back to her.

When appreciated property with debt is contributed, formation planning must compare the tax results by entity type. In a corporate formation, control by the transferors is necessary but not sufficient to avoid current tax; if the corporation assumes liabilities that exceed a contributor’s basis in the property transferred, that contributor recognizes gain to the extent of the excess. Nora’s land has an $80,000 basis and a $90,000 mortgage, so the corporate option would trigger $10,000 of gain. In an LLC taxed as a partnership, contribution is generally nonrecognition, but liability relief is treated like a cash distribution and is offset by the contributor’s share of partnership liabilities. Nora is relieved of $90,000 but is allocated back 70%, or $63,000, so her net relief is $27,000, which does not exceed her basis. That is why Jordan should first prepare the entity-by-entity formation calculation.

• Recommending the corporation immediately is premature because control alone does not eliminate gain when assumed liabilities exceed basis.
• Comparing only future tax rates skips a required formation analysis; basis, FMV, and debt can materially change current owner-level tax.
• Treating the full $90,000 mortgage as taxable cash to Nora ignores partnership liability allocation, which gives her basis credit for her 70% share.

A corporation would trigger $10,000 of gain because the assumed liability exceeds Nora’s basis, while the LLC reallocates 70% of the debt back to her so her net liability relief does not exceed basis.

Question 10

Topic: Entity Tax Planning

Ridge Partnership is planning a nonliquidating distribution to partner Nora.

• Cash to Nora: $15,000
• Land FMV: $90,000
• Land partnership adjusted basis: $80,000
• Nora’s outside basis immediately before the distribution: $65,000
• No liabilities shift and no Section 751 property is involved

A staff memo states: “The partnership must recognize the land’s $10,000 built-in gain, and Nora will take an $80,000 carryover basis in the land because the distribution is tax-free.”

What is the best correction to the memo?

• A. The partnership recognizes the $10,000 built-in gain, but Nora’s land basis is limited to $50,000.
• B. No gain is recognized by the partnership, but Nora still takes an $80,000 carryover basis in the land because nonliquidating property distributions use partnership basis.
• C. No gain is recognized by the partnership or Nora; Nora’s land basis is $50,000 after reducing her outside basis for the $15,000 cash, and her remaining outside basis is $0.
• D. Nora recognizes $15,000 gain on the cash distribution, and her land basis is $50,000.

Best answer: C

What this tests: Entity Tax Planning

Explanation: In a nonliquidating distribution, appreciated land generally does not trigger entity-level gain, and the partner recognizes gain only if money distributed exceeds outside basis. Nora’s $65,000 outside basis is first reduced by the $15,000 cash, leaving $50,000 available for basis in the land, so her land basis is $50,000 and her outside basis is reduced to zero.

For a nonliquidating partnership distribution, the partnership generally does not recognize gain or loss when it distributes property, even if the property is appreciated. At the partner level, cash reduces outside basis first, and the partner recognizes gain only when money distributed exceeds outside basis. After cash, the basis of distributed noncash property is generally the partnership’s inside basis, but it cannot exceed the partner’s remaining outside basis. Here, Nora starts with $65,000 outside basis and receives $15,000 cash, so no gain is triggered and her remaining outside basis is $50,000. The land’s partnership basis is $80,000, but Nora can take only $50,000 because of the basis cap. Her post-distribution outside basis is therefore zero.

• Giving Nora the full $80,000 carryover basis ignores the cap imposed by her remaining outside basis after the cash distribution.
• Treating the $15,000 cash as taxable confuses the rule; cash causes gain only when it exceeds outside basis.
• Keeping the partnership’s $10,000 built-in gain is incorrect because distributing appreciated property generally does not trigger partnership gain in a nonliquidating distribution.

In a nonliquidating distribution, cash reduces outside basis first, and the basis of distributed property cannot exceed the partner’s remaining outside basis.

Continue with full practice

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Related focused pages

• Free CPA TCP Full-Length Practice Exam
• CPA TCP: Individual and Personal Tax Planning
• CPA TCP: Entity Tax Compliance
• CPA TCP: Property Transactions

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