Kyle, Maria and Josh agree to form a general partnership to own and operate three buildings that consist of retail space and apartments. They will operate some of the retail space themselves and lease the remaining space. They are equal partners. Kyle contributed real estate valued at $2 million, Josh contributed other real estate valued at $2 million and Maria contributed her bakery business, with equipment and café furnishings valued at $500,000 and a cash contribution of $1.5 million. Maria arrives at the bakery at 4:00 am six days a week to make sure her cinnamon rolls and croissants are ready when the Café opens at 7:00 am. The partners agree that Maria should be allocated the first $30,000 of profits from bakery operations each year. The bakery operations produced $150,000 of ordinary income for the year.
a. Ignoring all other partnership items, will the special allocation of income to Maria be respected by the IRS? Why or why not.
b. Assume instead, that the special allocation to Maria of the first $30,000 of bakery income was made this year but next year Maria will also receive a special allocation of $30,000 of bakery deductions, before any deductions are allocated to the other partners. Will the special allocations be respected by the IRS? Why or why not?
c. Assuming no special allocations for any partners, the partnership sells the real estate contributed by Josh for $2.5 million. Josh’s adjusted basis for the real estate was $825,000. What amount of gain from the sale will be allocated to Kyle, Maria and Josh?