MLP at risk rules

[mlpabc1980]

Hello,

I have questions regarding an MLP (oil and gas PTP) .

1.  On the K-1 part two, box 12J has all positive percentages for profit, loss, and capital.  Box 12K  has positive numbers for non-recourse partners share of  liabilities.   Box 12L has a negative ending partners capital account.

 
Should I check the TT box for being at risk because the combined total of share of liability and ending capital account is positive, or am  I not at risk because only the ending capital account is negative?  I believe the negative  capital account is taxed as a capital gain.

2. When selling this MLP, there were passive losses allowed and passive losses not allowed.  Will the unallowed  passive looses be released to offset  ordinary income of this MLP sale? If not, the the losses be used to offest other non mlp income?

[nexchap]

On your questions:

1. There are two important numbers for partnerships:  how much "capital" you have at risk, and how much "basis" you have.  Your basis is the sum of nonrecourse loans plus your ending capital account.  But your capital at risk is only looking at your capital account.  So if that's negative, you no longer have capital at risk.
2. Since you said line J was all positive, I assume you did a partial sale?  TT will release passive losses to the extent that there is offsetting income, so if you have adequate losses they should cover your ordinary gain.  Suspended losses will only be released completely, and be available to offset other non-mlp income, when you sell completely.

One final note:  if you have no capital at risk, but still have basis, your statement about "negative capital account is taxed as a capital gain" isn't quite right.  Distributions "in excess of basis" are taxed as capital gain.  But if you still have basis, that doesn't apply.  What DOES happen is that a bunch of your losses are going to get suspended on form 6198 -- a special purgatory for losses that you won't be able to ever use unless you add more capital to the MLP.  So if you did a complete sale there's a portion of your losses that can't be claimed.

[mlpabc1980]

I did not sell any of the mlp this year or any prior years.   Here is the k1.

                           Beginning.            Ending

12 J. Profit.       .000082%.            .000080%

          Loss.        .000082%.            .000082%

          Capital.    .000082%.           .000080% 

                                                           Beginning   Ending

12K.  Nonrecourse                              29020     26225

Qualified nonrecourse refinancing.       0.         0

         Recourse.                                           0           0
12 L.    Beginning capital account.                 3089

            Capital contributed during year            0

            Current income or loss.                           107        

            Other increases or decreases.                0

            Withdrawals and distributions.           (3204)

            Ending capital account                            (8)

I  did not check the box in TT for having all of my investment at risk.  Hence, disallowed  and allowed losses were on form 6198.  Also, I put the the loss of 8 as a long term capital loss.

Now , I believe that all my investment is at risk.  I infer  that I am at risk based on this information from the K1 instructions for item K: “ Your share of nonrecourse  debt increases your tax basis in the partnership interest and allows you to treat distributions as non- taxable return of capital.  However, if your current year distributions exceed your tax basis, including non recourse debt allocated to you, the excess distributions are reportable as capital gain.”  Hence, the box in TT should be checked stating “ all of my investment in this activity is at risk”.

MLP’s  are maddening . I dont want to sell it but I dont want to buy more  shares and above all I dont want form 6198 to steal my passive losses.

[nexchap · Accepted solution]

You appear to be assuming that "investment at risk" and "basis" mean the same thing.  They are different.

The quote you included only discusses basis.  It doesn't mention "investment at risk".  And what it says about basis matches my previous answer:  you don't have to declare distributions as capital gains until your basis goes below 0.

But "investment at risk" is different.  Its literally referring to your investment:  the amount you put into the partnership yourself.  You didn't actually invest any of that "nonrecourse debt" money, and you're not liable for it.  So it doesn't count as "investment".  Your "investment" is what Section L is tracking.  When it reaches 0, the partnership is telling you that it has returned (from a tax standpoint) every penny that you gave them.  Some of it came back to you as actual distributions.  Some of it came back as losses which are suspended until you sell (but when you sell, you'll get to put them on your taxes offsetting other income).  So from a tax standpoint, you don't have anything "at risk".  If the partnership disappeared tomorrow, you've already gotten all your money out.

I hope that makes it clearer.

[mlpabc1980]

Thanks.  I will  buy shares to increase capital so as to be able to claim all of the passive losses carryover and not lose some of these losses from the purgatory form.  I will make sales over a few years to minimize the ordinary each year. 

[kstheory]

@nexchap

@mlpabc1980

First, nexchap, thanks for all the information you've provided across these MLP related questions.

I've been trying to figure out the at-risk limits myself. In this case, though, I think your answer to the at-risk question needs more context. The IRS asks whether the partner has ANY amount of investment NOT at-risk. This isn't the same as saying whether you have simply capital is at risk. If the partnership interest is in a MLP that has non-recourse financing, then there is an amount of investment representing the partner's interest (in partnership assets) that is not at risk. So at-risk loss limits, if any, must be checked even when the capital account is above 0 and there was a loss. From the instructions to Form 6198:

"File Form 6198 if during the tax year you, a partnership in which you were a partner, or an S corporation in which you were a shareholder had any amounts not at risk (see Amounts Not at Risk, later) invested in an at-risk activity (defined below) that incurred a loss."

In other words, Form 6198 has to be filled out with an MLP like this case. If at-risk loss limits don't apply, there's a good chance with many MLP situations that the passive-activity loss limits will kick in. The net change on Form 1040 might not be great if one has neglected to check the at-risk loss limits and losses are suspended in PAL. 

In the scenario where the capital account crosses into negative territory, the at-risk loss limits probably begin to kick in. This is where a difference maybe starts to happen. Any losses that might have survived all loss limitations in the prior year or two might get "recaptured" as income this year to bring amount at-risk back up to zero. **I'm still trying to get my head around this text in Publication 925, particularly the last sentence:

"Recapture Rule

If the amount you have at risk in any activity at the end of any tax year is less than zero, you must recapture at least part of your previously allowed losses. You do this by adding to your income from the activity for that year the lesser of the following amounts.

• The negative at-risk amount (treated as a positive amount); or

• The total amount of losses deducted in previous tax years beginning after 1978, minus any amounts you previously added to your income from that activity under this recapture rule.

Don’t use the recapture income to reduce any net loss from the activity for the tax year. Instead, treat the recaptured amount as a deduction for the activity in the next tax year."

[mlpabc1980]

Kstheory

this is a sound and reasoned solution.  I am not a tax person but previous  suggestions from many sources seem to conflict each other,  Your suggestions seems to reconcile the conflicts.

how would would report on which tax forms?

[nexchap]

@kstheory This is a subject that quickly gets so complicated that a tax professional ought to be involved.  I can provide answers at a simplified, top-level.  But if someone needs to get into the nuances (i.e., the moment the capital account goes below 0, they're into detailed calculations and definitions) professional help is the answer.

I don't get the sense that you're trying to change the end result of the answer above:

• Don't check the "All my investment is at-risk" box
• Don't assume that you have to declare distributions in excess of basis simply because capital account is below 0.  The nonrecourse liabilities provide basis.

Getting deeper than that is, in my mind, best avoided by simply keeping capital accounts positive.