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William Ellis, CPA
William Ellis, CPA, CPA
Category: Tax
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Experience:  Over 15 years of experience in public accounting
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I have purchased the interest of 5 limited partners in a LP

Customer Question

I have purchased the interest of 5 limited partners in a LP which holds title to an apratment complex with initial cost of approx. 13 million 6 years ago and a basis now of 11 million due to depreciation. Each of the LP that sold out to me had substantial negative basis on their K-1's a year ago due to the depreciation taken over the years.

I believe I can request the managing partner to reflect an adjustment to each of their final k-1's to bring their basis back to zero so they can use any passive loss previously held in suspence and reflect my initial capital at the amount I have paid to buy them out.

If that is correct does the MP then debit the balance sheet for a special asset "Capitalization Under Sec. 754" which can then be depreciated in the future for the amount of the credit he enters into the capital accounts to bring them back to zero?

I hope this is clear. thank you.
Submitted: 2 years ago.
Category: Tax
Expert:  William Ellis, CPA replied 2 years ago.

William Ellis, CPA :

Hello and thank you for allowing us at Just Answer to assist you. Is there a general partner? If you are the sole owner, then a new entity has been created, and you would allocate the assets based on the FMV paid. Unless there are remaining partners, you don't need to worry how the other partners record the transaction.

Customer:

You have not answered the question. I have purchased five of the eight LP- the GP has not changed. The partners bought out has accumulated negative capital of approx. $1.5 million. I invested several thousand. How do we adjust the B/S to reflect this and post it to the departing LP k-1's for the year?

William Ellis, CPA :

Has the apartment complex appreciated greatly over the past 6 years, or is the difference in basis primarily due to depreciation? If the complex (or other assets) has appreciated, it certainly would make since to make a Sec. 754 election. This basis adjustment from the Sec. 754 election will only affect your basis. It will not affect the other partner(s). The MP will not create any special asset. He will credit the balance sheet to remove the negative basis of the limited partners and to show your infusion of capital. He will debit the balance sheet to show the contributed cash.

Customer:

I assume the credit, which will be approx. $1.5 million goes to the capital accounts to zero them out. He will then credit my capital account for the $330K invested but you mentioned debit to the B/S for my cash only. Don't we also need another $1.5 million to the building to balance the entries and would that then be subject to future depreciation?

William Ellis, CPA, CPA
Category: Tax
Satisfied Customers: 296
Experience: Over 15 years of experience in public accounting
William Ellis, CPA and other Tax Specialists are ready to help you
Expert:  Rachel-Mod replied 2 years ago.
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Customer: replied 2 years ago.

You stated that he will credit the B/S for the 1.5 million negative capital accounts plus the 330K for the funds which I gave to the terminating partners for their interest and then debit the BS for my cash contribution. Perhaps I confused you. I did not give the cash to the partnership[- rather I negotiated with the terminated partners and bought out their interest.

 

They no longer hold an interest and the preliminary k-1 drafted by the accountnat shows them with a "Final" K-1 with huge negative basis.

 

I know we need to reflect a credit on their respective K-1's to zero out so when they credit capital on the BS for the 1.5 million where does the offsetting debit get posted.

 

Since my investment in the LP was not given to the partnership directly how do we get my 330K capital reflected on the books.

Expert:  BK-CPA replied 2 years ago.

Hello and thank you for your question.

.

We should slow down a little and visit the IRC 754 election. This will result in the partnership adjusting its inside basis in property. It will not result in adjustments to book balances (only tax basis balances). The basis adjustment should eliminate the difference between the fair value of the interests purchased and the inside basis in partnership assets attributable to the purchased interests. The adjustment is allocated to the partnership's assets per IRC 755. When these assets are later depreciated or sold, the additional deductions attributable to the basis adjustment are allocated to you using special allocations.

.

If the IRC 754 election is made, the partnership must adhere to it in the current and future years. While this may benefit you (the purchaser), an alternative is to decrease the purchase price of the partnership interests as an offset against the negative tax result of your purchase. I assume it is too late to do this, so an IRC 754 election becomes beneficial to you but a detriment to the partnership.

.

On a tax basis balance sheet, the departing partners capital accounts are simply allocated to you. Any increase in the inside basis of partnership property due an IRC 754 election would also increase your tax basis capital account. This will leave your tax basis capital account (plus any liabilities assumed) equal to the fair value of the partnership interest (purchase price of the interests).

.

Example:

Four 25% partners each have a tax basis capital account of $50,000 for a total of $200,000. The partnership has no liabilties. You purchase a 25% interest for $100,000. Absent an IRC 754 election, your tax basis capital account is $50,000 (as transferred from the departing partner) and your outside tax basis is $100,000 (equal to the purchase price). With an IRC 754 election, your tax basis capital account is $100,000 ($50,000 from the departing partner plus a $50,000 IRC 743 basis adjustment due the IRC 754 election) and your outside basis is $100,000 (again, equal to the purchase price).

.

Note that your outside basis will only equal your inside tax basis capital account (plus your share of any liabilities) with an IRC 754 election. If the partnership does not make an IRC 754 election, your outside tax basis remains what you paid for the interests (including your share of partnership liabilities), but your inside tax basis capital account will transfer from the departing partners.

.

As a side note, the passive loss rules are lifted in the final year of an activity (IRC 469), so the departing partners can use their passive losses regardless of what you or the partnership does.

.

Do not confuse a partner's tax basis capital account with a partner's outside basis in the partnership interest, as the two are quite different. A partner's outside basis will include his/her share of partnership liabilities and it does not directly appear as part of the Form 1065 partnership return or on the Schedule K-1's given to the partner. Rather, it is each partner's responsibility to track his/her own basis separately based on the amount paid for the interest, the fair value of any inherited interest, etc. A partner's inside tax basis capital account merely reflects the difference between the inside tax basis of partnership assets and liabilities. (ie... it is quite easy to have a negative tax basis capital account and a positive outside tax basis in the partnership interest, noting your outside tax basis in a partnership cannot be less than $0)

.

I hope this is helpful.

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