Brooke and John formed a partnership. Brooke received a 40% interest in partnership capital and profits in exchange for contributing land (basis of $30,000 and fair market value of $120,000). John received a 60% interest in partnership capital and profits in exchange for contributing $180,000 of cash. Three years after the contribution date, the land contributed by Brooke is sold by the partnership to a third party for $150,000. How much taxable gain will Brooke recognize from the sale?Single choice
A
$102,000
B
$90,000
C
$48,000
D
$36,000
E
$0

Question

Brooke and John formed a partnership. Brooke received a 40% interest in partnership capital and profits in exchange for contributing land (basis of $30,000 and fair market value of $120,000). John received a 60% interest in partnership capital and profits in exchange for contributing $180,000 of cash. Three years after the contribution date, the land contributed by Brooke is sold by the partnership to a third party for $150,000. How much taxable gain will Brooke recognize from the sale?Single choice

A

$102,000

B

$90,000

C

$48,000

D

$36,000

E

$0

BlackTom AI · Accepted Answer

First, restate the core facts of the scenario: Brooke contributes land with tax basis $30,000 and fair market value $120,000 in exchange for 40% partnership interest; John contributes cash $180,000 for 60% interest. The partnership later sells the land for $150,000. The key tax rule at play is 704(c), which ensures that any built-in gain in contributed property (i.e., FMV minus outside basis at the time of contribution) is allocated to the contributing partner when the property is disposed of by the partnership, to prevent shifting tax between partners.

Option 1: $102,000. This arises when you allocate the sale gain first to the built-in gain in the contributed property, which is $120,000 (FMV $120,000 − basis $30,000). The built-in gain at contribution is $120,000 − $30,000 = $90,000, which is allocated entirely to Brooke under 704(c) because she contributed the property. The remaining gain to be allocated from the sale is $120,000 total gain minus the $90,000 allocated under 704(c), leaving $30,000. This remaining $30,000 is then allocated according to Brooke’s and John’s partnership interests (40% and 60%), giving Brooke an additional $12,000 (0.40 × $30,000). In total, Brooke recognizes $90,000 + $12,000 = $102,000 of gain.

Option 2: $90,000. This would be correct if only the built-in gain allocated under 704(c) were recognized by Brooke, ignoring any additional allocation of the remaining gain. However, 704(c) does not exhaust the entire tax impact of a disposition; the non-704(c) share of the overall gain must still be allocated to the partners according to their interests, unless other special rules apply. Here, there is an additional $30,000 of gain left after the 704(c) allocation, which must be shared 40/60 between Brooke and John, respectively.

Option 3: $48,000. If you incorrectly apply only Brooke’s 40% share to the total $120,000 gain (ignoring 704(c) allocation mechanics), you’d get $48,000. But this ignores the fundamental 704(c) rule that predisposed gains in contributed property are allocated to the contributing partner first, creating an additional amount for Brooke beyond her 40% share of the total gain.

Option 4: $36,000. This could emerge if you misapplied the percentages or miscomputed the 704(c) allocation, such as assuming $90,000 total allocated to Brooke but then using a 40% of something else or misallocating the residual $30,000. The math would not align with the actual required allocation under 704(c).

Option 5: $0. This is incorrect because the sale produced a taxable event, and Brooke has a substantive built-in gain from the contributed property that is allocated to her, plus her share of any remaining gain. There is clearly taxable recognition, not zero.

In summary, the correct approach recognizes a $90,000 built-in gain allocated to Brooke under 704(c), plus Brooke’s share of the remaining $30,000 of total gain (40% of $30,000 = $12,000), totaling $102,000 of taxable gain for Brooke. The other options fail because they either ignore the 704(c) allocation mechanics or misallocate the residual gain among Brooke and John.