K-1 partnership liquidation gains appear excessive

[Evgen]

Hello. I've read several replies on this topic by @Rick19744 like This reply  and and This reply  but unfortunately I am still unclear on how to apply that to my situation, especially when Rick mentions "Your 'selling price' will be your liquidating distribution.  Make sure you don't double count this; include it in your basis calculation and then also as selling price."

Situation: I am reviewing my 2021 tax year return via TT. I was a passive LP in a real estate partnership, final K-1 in 2021.

I always thought that my basis was what I initially contributed, $50K. So I put this as basis, and $63K final distributions as sale price.

However, my capital acct (Sec L) went down over 4 years of partnership, from the original $50K to $4k (in simplified numbers). Entries:

Sec L:

* Beginning capital $4K

* Current year net income $59K - this is from 

      Sec III.2: $5K (RE income) and

           III.10: $54K (section 1231 gain)

* Distributions $63K (also reported in Part III 19.A)

Part III 9c: $7K (unrecaptured sec 1250 gain)

--------------------------

TT then added $13K (63-50 from sale), $5K, and $54K to result in $72K  gain. 

This looks excessive to me as, from the bank account point of view, I invested $50K, got back $63K and maybe $5K in distributions over the years). Is the calculation correct? Could this effect be accounting for the capital change from $50K to $4K? (BTW, I am afraid I missed the $34K loss carryover from 2019 to 2020 for this partnership, when I switched software from HR Block to TT :( )

How do I enter this correctly?

[Rick19744 · Accepted solution]

It appears that you don't have a solid understanding of how partnership tax works:

• A partnership does not pay any tax at the entity level.  All items of income, loss, capital gain or capital loss are passed through to the partner., and any tax is paid at the partner level.
• Each partner is responsible for maintaining their outside tax basis in their partnership interest.  While it may be close to the section L on the K-1, depending on when and how this is maintained, it is generally not your tax basis; this is known as a partner's tax capital (inside basis).
• Section L on the K-1 just recently was required to be maintained on a tax capital account basis.  Before that, it could have represented a number of different figures.  When this was required to be changed, we have no idea how the preparer determined the beginning figure.  But once again, each partner is responsible for their own tax basis.
• Your tax basis begins with your initial investment and is adjusted annually for the applicable lines on the K-1.  As a result, your tax basis is not a static figure.
• When adjusting your tax basis for the final year K-1, the liquidating distributions should not be used to adjust your tax basis (distributions will adjust the tax basis in every year except the final year k-1).  The liquidating distribution becomes your "selling" price.
• So simply based on your facts as presented, you will indicate in TT that this is a final k-1.  TT will then ask some additional questions:
  • You should respond that this is a liquidation of your partnership interest.
  • TT will ask for selling and purchase dates.  You should know these dates.
  • TT will ask for "selling" price.  This is your liquidating distribution of $63,000 as represented in your facts.
  • TT will ask for your cost basis in your partnership interest.  Based on your represented facts, this figure is $63,000 (4+5+54).  The $7,000 unrecaptured Section 1250 does not impact your tax basis.  This is only used when determining your applicable gain tax rate on the sale of the building at the entity level.
  • So based on the above, your facts, you have a selling price of $63,000 and a tax basis (cost basis) of $63,000.  No gain or loss upon liquidation will be represented on form 8949 or Schedule D.  While it will be reflected, there is no gain or loss based on your facts.
  • The above is assuming that Schedule L on your k-1 agrees to your outside tax basis.
  • You will still report the applicable lines from the final k-1 in TT just as any other year.  This just represents the sale of property at the partnership level and other activity which is passed through to the partner, who then pays the appropriate tax (and in which you received a distribution to pay any tax).

[Evgen]

Thank you, @Rick19744, for the quick reply!

Accounting is often counterintuitive to me.  🙂 My only question here, really, is about the basis. Other items I understand.

For example, when you say that basis should be "adjusted annually for the applicable lines on the K-1", how would I know which lines affect it? Hopefully, this is a non-issue for newer partnerships with K-1s beginning after 2019 or so, where Section L now represents the basis?

Similarly, why is 4+5+54 the new basis? It looks like entries from certain fields of Sec III get added to the previous value, excluding the liquidating cash distribution. Basically, what is the basis adjustment formula, and which fields are involved?

[Rick19744]

Response to your question:

• In general, a partner's tax basis is adjusted annually due to the fact that the partnership does not pay any tax at the entity level and all income, loss, gain, etc. gets passed through to the partner and is taxed at the partner level.  As a result, since these items are taxed annually, your tax basis gets adjusted annually for these items so there is no double tax.
• A complete discussion of tax basis is beyond the scope of a forum discussion.  There are too many boxes on a k-1 to go through the exercise of discussing the impact of each box.
• Based on your facts in the original question, the tax basis I reflected in my original response appears to make sense.
• While the IRS made a fairly recent change to how the capital account is reflected on a partnership k-1, the "new" tax capital could be a reasonable interpretation of a partner's outside tax basis.  However, it is the partner's responsibility to maintain an accurate outside tax basis.
• The instructions to the K-1 have a high level discussion of tax basis on page 4.