 Hello, and welcome to this session in which we would look at a CPA exam simulation that deals with a partnership distribution. This simulation is very popular with exam candidates that are received many requests about the simulation. Therefore, what I'm going to do, I'm going to go ahead and explain it in details. Before I start, I would like to remind you that if you're a CPA candidate taking the CPA exam, I strongly suggest you check out my website for health lectures.com. I do not replace your Becker, Roger, Glyme, Wiley, or any other CPA course. I can be a useful addition. I can add 10 to 15 points to your CPA exam score. I explain the material a little bit more in details. I explain the material as if you are still a college student. That's the difference between what I do in a CPA review course. And here's what you need to do. To try it, you have to subscribe for a month. Check me out, see if you like it. You keep it, otherwise you cancel. The maximum loss is $30. The gain is you could potentially pass the exam. I have helped hundreds, if not thousands of students to pass, check out my LinkedIn account, check out my LinkedIn recommendation, or check out my website to see other students that used my system. And if not for anything, check out my website to find out how well is your university doing on the CPA exam. I do have those scores. Also, I do have other accounting, finance, and tax courses. Please like this recording, share it, connect with me on Instagram and Facebook. So what I'm going to do with this simulation, I'm going to switch to Excel because it's easier, not easier. It's going to be better for you to use Excel. And this way, I can show you how to compute the figures, the partnership gain or loss, each partner's gains, losses, basis, and the property distributed and basis in the partnership interest. Let's go ahead and switch to the Excel sheet. So what are we looking for here? Well, we have three individuals, Adam, Lily, and Avi. Those are the three individuals that we are, the three partners, and they are equal partners. And this is their pre-distribution basis in the partnership, 11,500, 17,500, and 12,500. And we distributed asset. Adam, we gave them cash. For Lily, we gave Lily a land. We have the fair market value and the basis. And we gave Avi inventory, fair market value, and basis. This is what we gave them. Also, there was a debt secured by the land, and Lily is going to take over this debt. So this asset here has a debt, and Lily is going to take over the debt when she takes the land. So we have a few questions to answer. And the first question to answer is, what is the ALA partnership gain or loss recognize? Now, starting from this question, you might think simulations are difficult. Well, this is not a difficult thing. If you know the rules, this is going to take you two seconds to complete and make sure you complete. What does that mean? It's zero. They don't recognize a gain or a loss. So that's basically you just answer part of the simulation, and it takes you practically not no time, but it took you 10 seconds as long as you know the rules. Now, if you don't know the rules for this, if you don't know that you don't recognize a gain loss on this, then you're going to be stuck here. You're going to spend some time here. And obviously, if you don't know the rules here, you're going to find hard time, computing the gain and losses for Adam, Lily, and Avi. So it's very important that you understand this distribution. Well, obviously, we don't have to worry about the post distribution basis in the partnership interest, because this is for the partnership itself. Now we need to talk about Adam. Okay. First, what did Adam gets? Well, Adam received, we gave Adam $10,000 in cash. That's what we gave Adam. Excellent. Now, we have to be aware that cash could trigger taxable event. Simply put, as a result, if you received more than your basis, you could have a taxable event wide because it's cash, cash. So let's take a look at what we are doing here. The first thing is what's the gain or the loss that Adam should recognize? Well, let's see. Adam's basis is $11,500. Okay. Now, we have to remember that the partnership removed basically released the $6,000 of debt. When that happens, this debt is one-third to Adam, one-third to Lily, one-third to Avi. Remember, those are equal partners. Therefore, what's going to happen as soon as that debt is gone, we have to reduce Adam's basis. It's as we gave Adam $2,000 in cash as if we did that. So the first thing is, if there's any liability being removed, we have to reduce the sliability. Therefore, the adjusted basis of Adam's is $9,500. Now, look, Adam received $10,000 in cash. So $10,000. Remember, this is important. This is cash minus $9,500 in basis. Adam's will have $500. And that $500, guess what? It's a gain. It's again, if we have a loss, we don't recognize the loss, but it's a gain. And is it a taxable gain? Actually, it is. It is taxable. It is taxable because it's in form of a gain. So I have here negative $500, but it's really $500. So what I did is I took $11,500, reduced it by $2,000, gave a basis of $9,500, then we have a $500 cash. So this is, I'm just going to multiply everything by negative one. So no one is confused here just because of the formula. An Excel sheet, it ended up to be, so I'm going to multiply it by negative one. So it gives me $500 multiplied by negative one. So simply put, this is $500 gain, $500 gain. Okay? So this is an, and remember, Adam received cash, it's kind of a special asset in a sense that it's taxable. Now, post-distribution basis in the partnership interest. Well, what's the post-distribution basis? If we think about it, Adam started with $11,500, we reduced, we reduced the, we reduced it by $2,000 when they relieved the debt. That's $9,500. Then we gave Adam $10,000 off cash. Well, that gives us negative $500. Hold on a second. We cannot have negative basis. Therefore, the basis are actually zero. You cannot have negative basis. Therefore, the post-distribution basis for Adam is zero. The post-distribution is zero. You cannot have negative basis. Remember, Adam already recognized 500 off cash, which is taxable income. Therefore, the basis is zero. Basis in the property distributed, that should be easy. If we gave you $10,000 in cash, what is your basis in that $10,000 in cash? That should be the basis $10,000 in cash, $10,000 in cash. That's easy because it's cash. You don't have to worry about fair market value or whatever. Cash is cash. If you have $10,000, if we gave you $10,000, that's your basis $10,000. So this is Adam. Now let's take a look at Lily. First, Lily received land. Land will have a different, it will be treated differently than the cash. Remember, the cash is special. The cash is special. Why? Because it is taxable. You'll have a gain if you receive the cash and access of your basis, and that's what happened here. So what happened here? It's a property distribution. The first thing you need to know is there's no gain. So simply put, you don't have to do any computation. You could put zero here. There is no gain on this. Now, if you really want to compute, if you really want to compute the gain, if you really want to do that, well, we're going to do it in a moment. You'll have to compare. So let's assume we're going to compute the gain, but not recognize it just to kind of show you how it works. Remember, Lily, the basis is 17,500. 17,500. And remember, Lily, what's going to happen to Lily's basis, because Lily's taken over the debt. She already have one-third of this debt included in her basis, so she's going to get the remaining two-thirds. The remaining two-thirds is 4,000. Because remember, Adam's going to get root of one-third. That's going to go to Lily, and Avi's going to reduce the debt by one-third. It's going to go to Lily, one-third plus one-third equal to two-third. Therefore, Lily will increase her basis by $4,000. Therefore, her adjusted basis is 21,500. And she's receiving something for 9,000. There is no gain in the first place. But even if there's gain, remember, this is a property. We don't recognize a gain on it. Therefore, the gain is zero. The gain is zero. And it should be easy. Just put the gain is zero. Post-distribution basis and the partnership interest. What is Lily's post-distribution basis? Well, remember, we started with 17,400. We add the 4,000 because she's taken over the debt. And why do we only add 4,000? Because she already in her basis here, there is one-third of that debt. Then we add the one, the two-third of the other two partners. Therefore, we are up to 21,500. Then we gave Lily, then we gave Lily $9,000 of land. Therefore, we reduce it. We reduce the basis. We reduce the basis, but we reduce the land basis to Lily's basis. And what we end up with is 12,500. And this will be Lily's basis. 12,500. And here's the formula. And here's the note. Now, what is the basis in the distribution property? Simply put, what we're asking is now what basis with Lily takes in the land? Well, the basis are transferred since we have more basis interest, partnership interest basis than the basis of the asset. Basically, we're going to transfer the basis of the asset, which is 9,000. So notice here, the 9,000 will be the basis. Let's look at the third scenario. Again, what I like about this is it's basically looking at all different scenarios. Avi, Avi's basis, predistribution 12,500. Avi received inventory, fair market value of 10, a basis, partnership basis of 11. First, what's the gain or the loss? Again, it's zero. It's zero. The gain or the loss is zero. What is the post-distribution basis in Avi's? So Avi, a post-distribution, what's their basis? Now, again, we have to go through some computation here to find out the basis, to find out the post-distribution basis, starting with 12,500. Again, Avi will experience the same debt relief of 2000, that relief of 2000, minus 2000, which is the debt that Lily's taken over. That's going to be an adjusted basis of 10,000, 10,500. Then, notice what happened here. Then, Avi received an inventory with the basis of 11,000. Minus 11,000, basis of 11,000. Now, we have a negative. Can we have a negative? Can we have a negative? Can we have a negative basis? The answer is no. Therefore, what's going to happen? We're going to have post-distribution basis is zero. We cannot have negative basis. So no gain is recognized. No gain is recognized. Okay? No gain is recognized. Technically, if you think about it, we're giving them something that's worth 11,000 basis, and they have partnership basis of 10,500. There's a gain, but we don't recognize the gain, and we cannot have a negative basis. Therefore, it's zero. Now, what's the basis in the property? Now, here there's a special rule we have to be aware of. And what's happening here? The basis in the property, notice the basis in the property, the basis in the property here, is greater than the Avi's basis, Avi's basis, greater than the partner's basis. Okay? Under those circumstances, we're going to take the step down basis. The step down basis is Avi's basis, which is 10,500. Avi's basis, 10,500. Therefore, the inventory will have a basis to Avi of 10,500. Now, it's good to think about this. It's good to think about this. What happened if we give him, if we give Avi 11,000? Would Avi like it? Sure, Avi would prefer a basis of 5,000. Why? Because if he has a basis of 5,000, his basis are higher. Therefore, when he sells this property, he's going to have lower taxes. But we give him lower basis, which is 10,500. When he sells this property down the road, he's going to have a higher taxes. Therefore, the $500 here, we don't recognize, basically is the third into here. So notice, so although we gave him something for 11,000, has a basis of 11,000, he's going to have it as 10,500 because there are 5,000 that Avi did not recognize now. He would recognize later. When would he recognize later? When he sells the inventory, remember, inventory is ordinary income, FYI, that's something you have to know as a characteristic of the taxable income. Basically, again, I like this because it gives you, I like this exercise. For one thing, I received many, many requests for individuals to explain this simulation for them. I mean, this simulation, you would see it in many CPA review courses, something similar to it. Therefore, I just wanted to have this recording so you'll have it easy for you, easy for everyone to remember this. Once again, at the end of this recording, I'm going to remind you that if you're studying for your CPA exam, to check out farhatlectures.com, I don't replace your CPA review course. So if you want, you know, keep it. I can't replace it, but I can be a useful addition. I can add knowledge. I can add explanation. That's what really a supplemental course does. If a supplemental course is testing you or giving you the same thing as your main course, it's not a supplemental course. It's a mini course. I'm a supplemental course. I'm different, different in a sense that what I provide to you, your main menu, your main CPA review course, don't provide in this detailed explanation. Good luck, study hard, consider subscribing, and stay safe.