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Mary Dupuis, EA
Terry Anderson, EA, MST
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Why do we care about the partner’s basis?
• Without basis we cannot calculate:
• Amount of distributive loss taken
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Terminology
• Inside Basis: this is the A/B the partnership has in the assets that are in the
partnership. This may be assets donated by partners or acquired by the
partnership after formation.
• Outside Basis: the partner’s basis in the partnership. IRS refers to this as Interest
in the partnership
• Capital Account: The ‘book value’ of each partner’s share of the partnership.
• Book value: In this case, it is the Fair Market Value of the assets at the time they
are donated to the partnership or acquired by the partnership. Usually this
amount is not adjusted after the initial value.
• Recognized vs. realized gain or loss.
• Realized is actual gain or loss
• Recognized is the amount that needs to be reported on tax return
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Partnership Formation
• There is no gain or loss recognized
• There may be a realized gain or loss. FMV minus A/B
• The partner’s basis is equal to the A/B of the asset contributed at
formation.
• The partner’s capital account is equal to the FMV of the item
contributed, usually.
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Example: FMV is greater than A/B
Partner A contributes land with a FMV of $ 45,000, an Adjusted Basis of $40,000 in exchange for a
50% interest in a new partnership.
Partner B contributes $45,000 in cash.
A’s outside basis is calculated as follows:
Adjusted basis of land: $40,000
Built-in gain of $ 5,000 stays with partner A
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Example: FMV is less than A/B
Partner A contributes land with a FMV of $ 40,000, an Adjusted Basis of $45,000 in exchange for a
50% interest in a new partnership.
Partner B contributes $40,000 in cash.
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Encumbered Property
• Recourse Loan, liability less than the A/B of the contributed property
• Partner contributes property subject to a liability which the partner is
responsible for paying back
• The partnership takes on the liability
• The transaction is treated as if the partnership gave the partner cash. So the
amount of debt that the partner is relieved of is equal to his/her share of the
partnership and decreases his/her basis in the partnership
• The basis of the other partners in the partnership is increased by their portion
of the amount of debt that the partnership takes on.
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Example: Recourse Liability
Partner A contributes land with a FMV of $150,000, an Adjusted Basis of $50,000, and a mortgage
of $30,000 in exchange for a 50% interest in a new partnership.
Partner B contributes $120,000 in cash.
A’s outside basis is calculated as follows:
Adjusted basis of land: $50,000
Less: Portion of liability treated as a
cash distribution to A (1/2 of $30,000) ($15,000)
Equals: A’s outside basis $35,000
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Example: Recourse liability greater than A/B of property
Partner A contributes land with a FMV of $150,000, an Adjusted Basis of $10,000, and a mortgage
of $30,000 in exchange for a 50% interest in a new partnership.
Partner B contributes $120,000 in cash.
A’s outside basis is calculated as follows:
Adjusted basis of land: $10,000
Less: Portion of liability treated as a
cash distribution to A (1/2 of $30,000) ($15,000)
Equals: A’s outside basis $ 0
And A has a $5,000 recognized gain (does not affect outside basis)
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Example: Non-recourse greater than A/B, second tier and third tier
Partner A contributes land with a FMV of $75,000, an Adjusted Basis of $50,000, and a non-
recourse loan of $60,000 in exchange for a 50% interest in a new partnership.
Partner B contributes $120,000 in cash.
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Services in Exchange for Partnership Share
• If a partner receives a partnership interest for services they are being
compensated and should realize ordinary income. This is now the
partner’s basis in the partnership.
• Can come in two forms:
• Capital Interest
• Profit Interest
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Partnership Interest for Service
• Capital Interest - an interest in both future earnings and in the
underlying capital. If the partnership were to dissolve today then the
Capital interest partner will get a portion of the underlying assets.
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Capital Interest
• Income when the partner receives the asset – think of it as a deemed
sale and then a contribution
• Basis equal to the value of the asset minus any amount paid for the
asset
• Timing of income:
• Is it encumbered in any way?
• No – immediate income
• Yes – income when interest is transferable
• Partner can choose to elect under Section 83(b) to recognize income right away
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Capital Interest
• Nature of services.
• Capitalize the expense?
• Amortize the expense?
• Immediate deduction as wages or 1099 payment?
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Example: Capital interest in the partnership
A and B:
Cash contributed by each: $ 60,000
Less: Portion of assets allocated to C ($ 20,000) (each)
A’s and B’s outside basis (each) $ 40,000
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Changes in Basis
• Previous example assumed that the FMV of the property had not
changed.
• What if it had?
• What if the property had increased in value? So that the basis of the three
partners is now disproportionate because the new partner had 1/3 share of
current FMV and the other partners have their share of FMV at time of
formation.
• Is there a gain that needs to be recognized? A loss?
• Do any adjustments need to be done to the other partners’ basis?
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Profits Interest
• Don’t recognize any income unless:
• The partner sells their share within 2 years or
• There is a recognizable stream of income
• Same as with the capital income - what if the payment needs to be capitalized or
amortized?
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Example: Profits interest for service
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Property distributions
Distribution Sale
Partner B:
Basis in partnership (prior to distribution or sale) $ 50,000 $ 50,000
Built-in gain: $ 5,000 $ 5,000
Portion of remaining gain: $ 7,000 $ 7,000
Outside basis: $ 62,000 $ 62,000
Partner A:
Basis in partnership (prior to distribution or sale) $ 50,000 $ 50,000
Distribution: ($ 30,000) -
Gain on distribution: $ 7,000 $ 7,000
Outside basis: $ 27,000 $ 57,000 23
Partnership Takes on a Liability
• Affect on partner basis – increase by their share
• Assumes that all partners are equally responsible for the loan
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Partner sells partnership interest
• If you have this situation then you may need to do more research. It could affect other
partners’ basis
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Gain maintains its character as ordinary or capital gain
Increases in Partner’s basis
• The following items increase a partner’s basis in the partnership:
1. Adjusted basis from preceding year
2. Cash contributed and A/B of contributed property
3. Liabilities taken on by the partnership
4. Recognized gain on contributions
5. The partnership shows net income
6. Separately stated items – capital gains, interest and dividends, etc.
7. Tax exempt income
8. Depletion deductions in excess of basis
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Decreases to Partner’s Basis
• The following items decrease a partner’s basis in the partnership:
1. Losses
2. Liabilities of the partner that are taken on by the partnership
3. Taking cash out of the partnership
4. Receiving property from the partnership
5. Separately stated items such as capital losses, Section 179
6. Non deductible expenses: ½ meals, fines, penalties
7. Depletion deductions for oil and gas wells
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Backing Into Basis
• Why can’t you use the capital accounts to back into the outside basis?
• Capital accounts can go below zero, outside basis cannot
• Capital accounts do not reflect liabilities of the partnership
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Inputting a K-1
• The most important thing is to read the attachments.
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