Will I have to pay double taxes for the partnership income (Schedule K1-1065 Form)?

[manbeing]

I have a partnership in an organization. They give me the Schedule K-1 (1065 Form) every year. On this Form, it shows my partnership income, say $1,000, but the return of capital check I actually receive (Distributions) is only $350. When I use Turbotax to calculate the taxes every year, it always taxes based on $1,000, not $350 distribution.

I was told that when I redeem my partnership shares, the money I will get is:

For example, I purchase one share at $8,000  in 2015:

Share cost base =$8,000+ (total income listed in K1 from 2015 to the year you redeem your share)- (total return of capital check received in March 2016 to the year you redeem your share).

I am very confused because does it that mean I will have to pay the taxes again on the income when I redeem my shares?  Should they report the  return of capital check amount I actually receive every year as the INCOME on K-1 schedule (should not report the future income I will get when I redeem the shares on K-1 schedule)?

[Mike9241 · Accepted solution]

your tax basis is what you paid originally + all the income reduced by all the losses and deductions over the years and reduced by any distributions.  upon sale there is IRC 751 recapture which is treated as ordinary income and increases your tax basis.  if you sell, your capital gain is the difference between the selling price and your tax basis. 

 a return of capital check should reduce your basis 

example 

paid $8000 in 2015

income $1000 per year 2015-2022 8 years or $8000 total

basis is now $16000

distributions $350 per year 8 years  or $2800

basis is now $13200

say return of capital check $5000

basis is now $8200 

IRC 751 recapture $1800

basis is now $10,000

sell for $12000, capital gain $2000

lets see if this makes sense 

paid $8000

basis increased by income and 751 gain $9800 total $17,800

got $2800 in regular distributions

got ROC $5000

sold $12,000

total money you got  $19800 which is $2000 more than your basis'

another way to look at this is you got $19,800 for what you paid $8000 for or income of $11800

[manbeing]

@Mike9241Thank you so much for your reply and I think I might still need your help to understand my case.

Here are  my clarifications:

1. On my yearly Schedule K-1 (Form 1065), I have income $1,000 and I also receive the return-of-capital check ($350) every year.

2. I pay the Federal and State taxes on the income $1,000 through the tax return every year.

3. I was told that after I redeem my share (I purchased the share in 2015), I will receive the money = $8,000 (my original cost to purchase the share) +  (total income listed in K1 from 2015 to the year you redeem your share) - (total return of capital check received in  2016 to the year you redeem your share)

If so, will I have to pay the taxes again on (total income listed in K1 from 2015 to the year you redeem your share) ?

Thanks.

[PatriciaV]

No, you will be taxed only on the gain from the redemption. You have already paid taxes on the income that increased your basis. The return-of-capital payments are not taxable but do reduce your basis, which increases any potential gain.

Mike9241 provided an excellent example of how the gain is calculated. The bottom line is that you are taxed on the increase in the value of your investment when it is sold.