K1 tax implications for an LP in an investment fund

[arnaud7]

Hello,

I'm really struggling to understand how K1 income and deductions impact my tax return in the context of being an LP in an investment fund.

I mostly have two relevant items here:

Some income under line 11, code A, as "Other portfolio Income"

Some deductions under line 13, code W as "Other portfolio deductions"

Regarding the income, I selected in Turbotax:

"Other Portfolio Income (Loss) to be Reported on Schedule E, Page 2"

I assume that is correct? 

Regarding the deductions, I can either select:

A) Nonpassive Deductions to be Reported on Schedule E, Page 2 

That allows for my deductions to be deducted and offset my income above.

B) Miscellaneous Itemized Deductions

That causes my deductions to be found nowhere in my printed tax return and do not offset any of the income

I assume the key is understanding wether or not the deductions are passive or non-passive? For which the footnotes have two contradicting paragraphs:

1) Prior to January 1, 2018, taxpayers could deduct miscellaneous itemized deductions that exceeded 2% of Adjusted Gross Income ("AGI"). Starting in 2018, individual taxpayers can no longer deduct such expenses. Your share of these deductions is reported in Box 13 Code W as "Other Portfolio Deductions." Please consult your tax advisor.

2) Unless otherwise noted, the distributive share of all income and expense items reported to you on Schedule K-1 is from trading personal property and should not be considered as derived from a passive activity under Treasury Regulation Section 1.469-1T(e)(6). As such, your distributive share of income, gains, losses and/or deductions reported to you on your Schedule K-1 should not be subject to the passive activity limitations of Internal Revenue Code Section 469. Please consult your tax advisor.

That makes if very confusing to me as wether the deductions are non-passive and deductible or if they are misc itemized deductions that can't be deducted since 2018?

If they can't be deducted (which is what I think is the case?) I do not understand what's the logic here. My income within the fund increases my tax liability but my losses are not able to reduce it? I end up potentially paying income taxes on a net loss if I have more deductions than income? Seems weird? 

Any element of clarification would be much appreciated... thanks

[Rick19744 · Accepted solution]

A few comments on your questions:

• Based on your facts, I assume you are invested in a hedge fund
• These entities are structured with top level advisors who understand the very complicated tax world that covers the tax implications
• The good news is that, while generally LPs are passive investors subject to the passive activity regulations, this fund is telling you that they fall outside of those rules and cite the specific regulation.
• When entering the information in TT, indicate that you materially participate in the activity.
• Unfortunately, the amount reflected on line 13 is telling you that the expenses attributable to your income are deemed "portfolio expenses".  The K-1 also indicated that these type of expenses are not deductible at the present time; 2018 through 2025.
• It is also very important that you track your investment in the LP; known as your tax basis.  Both of these items will impact your tax basis.

[arnaud7]

Thanks for the tips really appreciate it!

The material participation question isn't asked to me cause when asked if there is an amount in line 1, 2, or 3 I selected "other" because all lines are empty (no amount at all).

Should I select line 1 and write zero instead even if the K1 is empty?

[Mike9241]

individuals can no longer deduct portfolio expnses for federal purposes (line 13 w). some state may allow the deduction

[Rick19744]

@arnaud7 the key to your question is how TT handles the amount designated "other portfolio income".

You will want to review your return and make sure that this is not being reflected as passive.

TT is a solid tax preparation software, but it is designed for the masses, and sometimes, you need to make adjustments, or possibly answer a question differently than expected to get it to report an item correctly without overriding; which in most cases would preclude efiling.

[arnaud7]

Thanks for everything! I think I'm good to go.

The only thing that puzzles me is when looking at the generated Schedule E, Part II line 28:

In the name column I have 3 rows:

- One with the name of the fund

- "Other Income"

- "Other portfolio deductions"

Then for the amounts of income and loss, the first row corresponding to the fund name is empty, and the fund's income and losses are respectively reported on row 2 and 3.

Is it normal that it uses 3 rows instead of condensing everything in the same row with both income and losses? If it isn't normal how am I supposed to fix this?

Thanks

[PatriciaV]

Yes, this is the correct format for the line items you listed. Put another way, this is what the IRS expects.