Reporting the Results of

Partnership Operations

Partnership Compliance

Although partnerships dont pay taxes, they are required to file

Form 1065, U.S. Return of Partnership Income, with the IRS
by April 15 for a calendar year partnership
Page 1 of Form 1065 shows details of calculation of the
partnerships ordinary business income (loss) for the year
Page 3, Schedule K, lists the partnerships ordinary business
income (loss) and separately stated items
Schedule K-1s are included with Form 1065 when it is filed,
and Schedule K-1s are also separately provided to all partners

20-1

Reporting the Results of

Partnership Operations

Ordinary business income (loss) = revenue expense

Separately stated items, treated differently from ordinary
business income for tax purpose. Separated stated items
are taxed differently at partners level

Common separately stated items include: Interest income;

Dividends; Capital gains; charitable contribution; fines and
penalties; tax-exempt income; guaranteed payment;

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Reporting the Results of

Partnership Operations
Guaranteed

Fixed amounts paid to partners regardless of profit or

loss earned by partnership (similar to wage payment)
Generally deducted in computing a partnerships
ordinary income or loss for the year (like a wage
expense)

Payments

Does not directly affect partners tax basis calculation

Separately stated to the partners receiving them

Treated as ordinary income by partners receiving
them (similar to salary income)

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Partner's Adjusted Tax Basis in

Partnership Interest

Partners make the following adjustments to the basis in

their partnership interests annually:

Increase for actual and deemed cash contributions to the

partnership during the year
Increase for partners share of ordinary business income
and separately stated income/gain items and tax-exempt
income
Decrease for actual and deemed cash distributions during
the year (debt relief for partners)
Decrease for partners share of nondeductible expenses
(fines, penalties, etc.), ordinary business loss and
separately stated expense/loss items
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Partner's Adjusted Tax Basis in

Partnership Interest

Cash Distributions in Operating Partnerships

Partners are taxed on income when partnership earns it but

not when distributed
If cash is distributed when partners have a positive tax basis in
their partnership interests, the distribution effectively
represents
Return of capital previously contributed by the partner to the
partnership
Cash distributions (deemed or actual) in excess of a partners
basis are taxable and are generally treated as capital gains
Partners basis cannot be negative!

20-5

At the beginning of year 2, Tony had a tax basis of $40,000 in Tall

Ladders, Limited Partnership. Tony has a 20 percent profits interest.
Tall Ladders will pay Tony a $10,000 guaranteed payment for extra
services he provides to the partnership. What is Tony's adjusted tax
basis at the end of year 2 (Tony meets all three loss limitations)?

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Loss Limitations

Operating losses, can generate current tax benefits

when partners can deduct them against other sources of
taxable income
Ordinary losses from partnerships are deductible against
any type of taxable income
Losses are deductible on the partners tax return only
when they clear all three separate hurdles
Tax basis
At-risk amount
Passive activity loss hurdles
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Loss Limitations

Tax Basis Limitation

In a sense, partners basis represents the amount a

partner has invested in a partnership or may have to
invest to satisfy her debt obligations
Partners may not utilize partnership losses in excess
of their outside basis in their partnership interests
Losses allocated in excess of their basis must be
suspended and carried forward indefinitely until
partners have sufficient basis to utilize the losses
Partners may create additional tax basis by making
capital contributions
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Loss Limitations

At-Risk Limitation

More restrictive when compared to tax basis limitation

Limits partners losses to their at-risk amount
Adopted to limit the ability of partners to use nonrecourse
debt as a means of creating tax basis
Only nonrecourse debt considered to be at-risk is
nonrecourse real estate mortgages from commercial
lenders called qualified nonrecourse financing
Losses limited under the at-risk hurdle are carried forward
indefinitely until
Partners

generate additional at-risk amount, or

They sell the partnership interests
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Adapted example 20-25

Suppose Nicoles beginning tax basis in CCS
partnership is $4,000. During the year, Nicoles
basis increases by dividends of 150, long-term
capital gains of 90, nonrecourse debt of 9,000.
Nicoles share of ordinary business loss is
(18,240). What is her loss suspended by the
tax basis hurdle and the at-risk hurdle? How
much loss can she deduct eventually?

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Loss Limitations

Passive Activity Loss Limitation

Enacted as a backstop to the at-risk rules and are applied after

the tax basis and at-risk limitation
Applies primarily to individuals and also to estates, trusts,
closely held C corporations, and personal service corporations
Limits the ability of partners in rental real estate partnerships
and other partnerships they dont actively manage from using
their ordinary losses from these activities to reduce other
sources of taxable income
Passive activity
Activity

which involves the conduct of a trade or business, and in

which the taxpayer does not materially participate

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An individual other than a limited partner can be classified as a material

participant in an activity by meeting any one of the seven tests

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Passive Activity Loss

Limitation

Under the passive activity loss rules, each item of a

partner's income or loss from all sources for the year is
placed in one of three categories or baskets.

Passive activity income or loss

Portfolio income
Active business income

This limits partners ability to apply passive activity

losses against income in the other two baskets
Passive activity losses are suspended until the taxpayer
generates passive income, or until the taxpayer sells the
passive acitivity
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Adapted example 20-27

This example follows example 20-25. Now, Nicole has 4,240 ordinary
loss allocation from CCS clearing both the tax basis and at-risk
hurdles. Assume Nicole was not a managing member of CCS during
2014 and could not satisfy one of the seven material participation tests.
How much of the $4,240 ordinary loss can she deduct on her tax
return, assuming she has no other sources of passive income?
Answer: None. Under this assumption, the $4,240 is a passive activity
loss and suspended until Nicole either receives some passive income
from CCS (or some other source) or sells her interest in CCS. So, she
will have $4,240 loss suspended due to the passive activity limitation.

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Homework
41;

42 (a, b, c); 43 (a, b, c); 58; 59;

20-15

Loss Limitations

passive activity losses are

suspended

20-16