Partnership Taxation: Partner's Basis.

In this video, we explain partner's basis in a partnership.

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Partner's Basis in a Partnership
A partner's basis in a partnership represents their investment in the partnership for tax purposes. It is crucial because it determines the taxability of distributions, the deductibility of losses, and the gain or loss on the sale or disposition of the partnership interest. The basis can fluctuate over time due to contributions, withdrawals, income, and losses.

Initial Basis
The initial basis of a partner's interest depends on how the interest was acquired:

Contribution of Property or Cash
Basis equals the cash contributed plus the adjusted basis of any property contributed.
For property, the partner's basis is adjusted by any liabilities assumed by the partnership or the partner.

Purchase of an Interest
Basis equals the purchase price paid for the partnership interest.

Gifted Interest
Basis is generally the donor's adjusted basis, adjusted for gift tax paid.

Inheritance
Basis is the fair market value of the partnership interest at the date of death or alternate valuation date.

Adjustments to Basis
A partner's basis is not static; it is adjusted annually for the following items:
Increases to Basis
Additional Contributions
Any cash or property contributed increases the basis.

Share of Partnership Income
Includes both taxable and tax-exempt income allocated to the partner.

Increase in Share of Partnership Liabilities
The partner’s share of any partnership debts increases their basis.

Decreases to Basis
Distributions
Non-liquidating cash or property distributions reduce the basis (but not below zero).

Share of Partnership Losses
Includes ordinary losses, capital losses, and other deductible items allocated to the partner.

Decrease in Share of Partnership Liabilities
Any reduction in the partner’s share of partnership debt reduces their basis.
Partnership Liabilities and Basis

Liabilities play a critical role in determining a partner’s basis. The allocation of liabilities depends on the nature of the liability:
Recourse Liabilities
Allocated to partners based on their share of economic risk of loss.

Nonrecourse Liabilities
Allocated based on profit-sharing ratios unless special rules apply.

Loss Limitations
A partner’s ability to deduct losses from a partnership is subject to the following limitations:
Basis Limitation
Loss deductions are limited to the partner’s basis in the partnership interest.

At-Risk Rules
Deductible losses are further limited to the amount the partner has at risk.

Passive Activity Loss Rules
Losses from passive activities can only offset income from other passive activities.

Partner's Basis vs. Capital Account
It is essential to distinguish between a partner's basis and their capital account:
Capital Account: Reflects the partner’s ownership interest and economic investment in the partnership. It does not include liabilities.
Basis: Includes the partner's capital account plus their share of partnership liabilities.

Calculation Example
Scenario: A partner contributes $50,000 in cash and property with an adjusted basis of $30,000 and a fair market value of $40,000. The partnership assumes a $10,000 liability associated with the property.

Initial Basis: Cash+Adjusted Basis of Property−Liabilities Assumed by Partnership
50,000+30,000−10,000=70,000

Adjustments Over Time:
If the partnership allocates $20,000 of income to the partner, their basis increases to $90,000.
If the partner receives a $15,000 cash distribution, their basis decreases to $75,000.

Importance of Basis
Tax-Free Distributions
Distributions up to the basis amount are tax-free. Amounts exceeding the basis are taxed as capital gains.

Deduction of Losses
Losses can only be deducted to the extent of the partner's basis, preventing deductions that exceed the partner's investment.

Gain or Loss on Sale
The partner’s basis determines the gain or loss when selling or transferring their interest.

Conclusion
Understanding and tracking a partner’s basis in a partnership is essential for accurate tax reporting and planning. Properly calculated basis ensures that partners comply with tax rules related to distributions, losses, and gains on the disposition of partnership interests.


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