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Don and Paul each contribute $50 to their newly formed general partnership (each partner is required to restore any deficit in the partner's capital account upon liquidation of the partnership). The partnership borrows $900 on a recourse basis and buys a $1,000 building. The building generates $100 of depreciation a year for ten years, and the partnership has no other items of income or loss. The partners agree to allocate all losses equally until their capital accounts are zero; after that the partnership specially allocates all losses to Don. Assume that capital accounts are maintained in accordance with the rules in Regulations §1.704-1(b)(2)(iv) and that liquidating distributions are to be made in accordance with positive capital account balances.

a. Do the allocations have economic effect?

b. Would the answer to problem 6a change if Don and Paul form a limited partnership with Paul serving as the general partner. Can anything be done to prevent reallocation of the losses?

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