Why does k-1 income raise cost basis?

[akk2]

Hi,

I received a K-1 from Proshares VIX (a fund that allows me to short-sale the SP500). The K-1 lists an income of X dollars, but it appears from the instruction that I should not report the K-1 but rather adjust my cost basis from the purchase and sale of the fund.

However, though the K-1 lists the X dollars as income, the sale adjustment asks me to raise my cost basis by X dollars, which would actually lower my capital gains and lower my taxes.

It doesn't seem logical. Any help would be much appreciated.

[akk2]

The only way I can make sense of that is if the cost-adjustment is supposed to offset the income on K-1 so I am left with the capital gain/loss as it appears on the 1099B. 

[jtax]

Other than line L, what other boxes on the K-1 have entries? Based on the Proshares VIX web help, I'm guessing that you have something in box 11, code i. Let me know if I'm wrong.

See this older discussion info: 

https://ttlc.intuit.com/community/taxes/discussion/how-to-enter-k-1-form-1065-box-11-code-i-other-in...

It describes how you enter box 11 code i info ... basically you need to tell TT what kind of income it is so TT can put it in the right place. As the Proshares VIX help info explains this likely "phantom" income. I.e. you didn't get any cash but you have taxable income. (Likely increasing the value of the underlying investment.)

A couple of things that might be helpful to you. 

The box L capital account reconciliation doesn't necessarily represent income. Distributions might or might not be income. They could also be a return of capital. Or there could be a loss.

If you have "phantom income" that you are taxed on, that will increase your basis. Think of it as avoiding double taxation. E.g. you buy in for $100. You get $5 of phantom income (no distribution). Adjusted basis is $105. You sell for $107. You have $107 - $105 = $2 capital gain. If you didn't get a increase in basis you would have a $7 gain, but that would tax you twice on your $5 phantom income.

If you get a distribution that will reduce basis.

For more info on partnership basis see 

https://www.irs.gov/publications/p541#en_US_202102_publink1000104291

Just warning partnership taxation can be terribly complex. there is an inside basis and an outside basis. you probably don't need to worry about all that though for this kind of partnership.  Just be sure you get the income 

When you sell you box L should give you your current basis (you should be able to verify given the above and the history over the years of your investment).  You gain is simply your proceeds from the sale minus your basis. TT should ask you about all of that if you indication you have disposed of the your partnership interests.

If you have more questions, feel free to ask.

[akk2]

Thanks jtax. Super helpful. Will need some time to process all this. 

Just to answer your questions.

There is nothing in Box K.

The loss amount from L is split into  Box 11 code C and  Box 13 code W*  

Basically: Box 11 - Box 13= L

The Box 13 amounted is also reproduced in 20B (I am assuming they are the same for a reason).

[jtax]

Ok, that is helpful. 

First, did you sell all or part of this in 2020? When did you buy it? (Was it bought and sold all in 2020 or did you own it for more than one tax year?)

Re: Box 11 code C, that amount, as described in the investment's k-1 FAQ's is (for reasons not worth going into) capital gain income to you. Even though may not have received any cash distributions. It is considered 40% short term and 60% long term. You should see those amounts on your Schedule D, line 4C and 11D.

Your basis in the partnership is increased by this amount because you are taxed on it. 

Re: Box 13. This is a deduction. When you enter the box 13 info how did you describe what the expenses were? They may or may not be deductible depending upon what they are.

I think but am not certain that your basis is usually decreased by the 13W amounts. This seems right for deductions but also seems to be the case for non-deductible items. This is complicated and you should probably seek professional advice, especially if the amounts are not small. See https://www.irs.gov/pub/irs-pdf/p541.pdf page 10 under decreases: "The partner's basis is decreased (but never below zero) by the following items ... The partner's distributive share of nondeductible partnership expenses that are not
capital expenditures."

I am a bit confused when you say line L is a number. L is a calculation of your current basis. It might or might not be tax basis. Basically it shows what your basis was at the beginning of the year, how much you contributed to the partnership (+ basis), how much income you received (+ basis), how much cash/property you received (- basis) and how much basis you have at the end of the year. In the year of sale the ending capital account should be zero.

When you sell and tell TT that it will obviously ask you for your proceeds and your adjusted basis. Then it will tax you on the gain (or loss). 

[akk2]

Thanks, jtax. Super helpful.

I think I understand the basic logic of it now. Because PTP income is taxed differently from capital gains, the government wants the K-1 income reported as such and then the basis is adjusted so I am not double-taxed on that amount as a capital gain... I know, baby steps...

[jtax]

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@akk2 wrote:

Thanks, jtax. Super helpful.

I think I understand the basic logic of it now. Because PTP income is taxed differently from capital gains, the government wants the K-1 income reported as such and then the basis is adjusted so I am not double-taxed on that amount as a capital gain... I know, baby steps...

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Yes, that is correct. Partnership taxation is very complex. And used for investments but also businesses (usually as LLCs or S-corps). A lot of rules are in place to avoid gaming the system.

Oh, one thing. You are correct about the 11C being capital gain. But the basis adjustment when you receive phantom income applies to any type of income, not just capital gain. If you actually receive the cash for the income your basis obviously does not increase, just like a dividend from a stock does not increase your basis. If you reinvest the income by buying more shares/units then it is the that purchase increases your basis.