Lost all K-1 Investment. How to claim deduction?

[daewoorocks]

Hello, 

I am an individual general partner in ABC, LLC. 

ABC, LLC invested as a limited partner in XYZ, LLC a few years ago. 

During these years, I filed my individual K-1s for ABC.

In 2019, ABC's share went to 0%.  A final K-1 from XYZ was given to ABC. 

I received my K-1 from ABC.  It is not the final K-1, as ABC continues to exist.  

Can I deduct the loss of my capital in XYZ from my regular 2019 income?  It seems the only way to get TurboTax to recognize this loss is if I select that the partnership ended in 2019.  However, ABC still exists.   I tried selecting to dispose of a portion of my interest, but when I filled in the data, it did not apply to my regular 2019 income.  

Thanks for any/all help.  I'm happy to provide more info if needed. 

[jtax]

My first thought is that if ABC continues to exist and you still own the same interest in ABC then you haven't lost money on it. If it (ABC) has recognized the loss in XYZ it should pass your share on to you by a negative number in box 8 or box 9 of the 1065 K-1. You could ask the LLC manager about that.

Note also that just because an investment goes to zero doesn't mean you have "recognized" the loss. For a security to be worthless it must be permanently worthless, no chance of going up in value. ABC would need to make that determination. For general info on worthless securities and loss deductions see https://www.thetaxadviser.com/issues/2012/sep/clinic-story-07.html

What boxes have an entry in them. Don't need the amounts, just what boxes. If it's boxes with codes (like box 20) give the code also.

[daewoorocks]

Thank you @jtax for your response.  

For simplicity's sake, let's just say that ABC's share in XYZ is now permanently worthless, ie there is no chance of it going up in value. 

For every year that ABC was invested in XYZ, there has been a capital loss, ie. Box 8/9 has been negative every year, culminating in 2019 with the complete loss of all ABC's initial capital investment.  XYZ sent a final K-1 to ABC, and ABC then sent my individual K-1 (not final).  Is there any way for me to deduct ABC's loss from my 2019 personal taxes while I am still a shareholder in ABC?  Or do I have to wait until the year I dispose of my interest in ABC completely?  

To answer your question, the K-1 has entries in Box 1, 9a, 14 (A), and 20 (Z)

Thanks again!

[jtax]

@daewoorocks glad to help as best I can. (FYI this is mostly a volunteer forum).

The amounts in box 8 and 9 are deducted in the year of the K1. They go to Schedule D line 5 or line 12 (CG from k-1s for partnerships, s-corps, estates, and trusts). (LLC's are taxed as partnerships unless they elect to be taxed as a corporation, which is unlikely for an investment vehicle.)

So my first suggestion is that you check your 2019 and prior year Schedule Ds to see if those losses have already been deducted. If they have been reported in Box 8/9 they should be. 

Do note that capital losses can only be used to offset other capital gains. If there aren't enough capital gains, then only $3000 a year can be used to offset ordinary income.

Also there could be a passive income limitation at play here.

When you are a passive investor in an LLC (i.e. the LLC isn't one that you work in as  a job e.g. a landscaping business that you run), most losses from the LLC are considered passive. Boxes 8/9 are not. Passive losses in a given year can only be used to offset other passive income. Frequently one doesn't have enough passive income, so the excess passive losses are "suspended" and carried forward into the future.

When you dispose of ALL of your interest in the passive investment in a fully taxable transaction (i.e. sell/redeem your interests/shares or the investment LLC winds up (final K-1), then your prior year suspended passive losses are "allowed" in the year of disposition. That will show up usually on Schedule E though some can show up on Form 4797. 

In TT take a look at your K-1 form in forms mode (Desktop software) or perhaps the PDF in online (I don't use online so I'm not sure) and see "Section A" (generated by TT) for how the gain loss is split up and if it is limited by the passive activity rules.

Feel free to ask more if that doesn't make sense.

[daewoorocks]

@jtax thanks again for your thorough response. 

I misspoke in my last reply.  I originally said, "For every year that ABC was invested in XYZ, there has been a capital loss, ie. Box 8/9 has been negative every year, culminating in 2019 with the complete loss of all ABC's initial capital investment."  This is incorrect.  Looking back at my previous years K-1's, I see that Box 8/9 have been blank every year.  Box 1 has had a negative amount every year.  2019 is the first year that Box 9 has a value in it, after XYZ issued their final K-1 to ABC.  

You are correct that there is a passive income limitation here.  Looking at Section A, I see a positive number in column (a) Gain (Loss Limited by form 6198), negative number in column (b) Suspended Loss Carryover from Prior Year, a zero in column (c) Net Income (Loss) Allowed, and a negative number in column (d) Loss Suspended for Current Year.  

This makes me think that there is no way to use the loss in XYZ towards my 2019 tax returns (I have no other passive income).  Only when I dispose of my entire interest in ABC will I be able to use my losses in that tax year.  Does this sound correct?  

Thanks again for your help.  I learn more about our tax system every year.  

[jtax]

@daewoorocks Ok. Thanks for the update.

Learning about passive losses is always a surprise for people.

So you are right that absent other passive gains you will not recoup your box 1 suspended passive losses until you sell or dispose of your entire interest. (See below for a detail example from IRS Pub 925).

[There is an exception if a passive activity can be split into two activities and one is fully disposed of. Maybe for example if there were two rental properties, don't know. Also it is possible to fully dispose of something even though you get ongoing payments for it over more than one year--an installment sale. Then each year's payments received are allocated some to interest, some to gain or loss. But you no longer have a profit or loss interest in the asset you sold].

It seems that box 8/9 (and probably other boxes re: interest/dividends) are for income from investments in the LLC's portfolio and that income/loss is by definition not passive b/c it does not come from the business of the LLC. I don't know much about this so I can't make certain statements. But it seems like portfolio losses (or income) will just hit your Schedule D (or Schedule B if dividends/interest) in the year you get them. The passive losses are all about income/loss generated by the business the LLC is in. See below.

IRS Pub 925

https://www.irs.gov/publications/p925#en_US_2019_publink1000104597

Passive Activity Income

Passive activity income includes all income from passive activities and generally includes gain from disposition of an interest in a passive activity or property used in a passive activity.

Passive activity income doesn’t include the following items.

...

Portfolio income. This includes interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business. It includes gain or loss from the disposition of property that produces these types of income or that’s held for investment. The exclusion for portfolio income doesn’t apply to self-charged interest treated as passive activity income. For more information on self-charged interest, see Self-charged interest , earlier.

Another example from IRS Pub 925, https://www.irs.gov/publications/p925#en_US_2019_publink1000104597

Dispositions

Any passive activity losses (but not credits) that haven’t been allowed (including current year losses) are generally allowed in full in the tax year you dispose of your entire interest in the passive (or former passive) activity. However, for the losses to be allowed, you must dispose of your entire interest in the activity in a transaction in which all realized gain or loss is recognized. Also, the person acquiring the interest from you must not be related to you.

If you have a capital loss on the disposition of an interest in a passive activity, the loss may be limited. For individuals, your capital loss deduction is limited to the amount of your capital gains plus the lower of $3,000 ($1,500 in the case of a married individual filing a separate return) or the excess of your capital losses over capital gains. See Pub. 544 for more information.

Example.

Ray earned a $60,000 salary and owned one passive activity through a 5% interest in the B Limited Partnership. In 2019, he sold his entire partnership interest to an unrelated person for $30,000. His adjusted basis in the partnership interest was $42,000, and he had carried over $2,000 of ordinary passive activity deductions from the activity.

Ray's deductible loss for 2019 is $5,000, figured as follows.

Amount realized		$30,000
Minus: adjusted basis		–42,000
Capital loss		$12,000
Minus: capital loss limit		–3,000
Capital loss carryover		$9,000
Allowable capital loss on sale		$3,000
Carryover losses allowable		2,000
Total current deductible loss		$5,000

Ray deducts the $5,000 total current deductible loss in 2019. He must carry over the remaining $9,000 capital loss, which isn’t subject to the passive activity loss limit. He will treat it like any other capital loss carryover.