No, as a practical matter, outside basis should be tracked yearly because basis is an accumulated amount from prior and current years and it may be difficult or impossible to compile the needed data when necessary.
Generally, a partner’s outside basis starts with the partner’s initial basis in the partnership interest, and is adjusted for: (a) all subsequent contributions by the partner; (b) the partner’s share of the taxable income or loss of the partnership; (c) the partner’s share of the nontaxable income and nondeductible/non-capital expenses; and (d) the distributions from the partnership --up to the date that basis is determined
And, of course, basis determination must be made whenever there is a possibility of a taxable event
Also, any receipt of a partnership interest by providing services to the partnership is initially taxed as the receipt of compensation at fair market value, and this value becomes the opening basis in the interest.
With respect to determining the gain or loss from the partial or complete disposition of the partnership interest, and with respect to determining the basis of any property received from the partnership as property distributions, outside basis should be determined immediately prior to the disposition or the distribution of the property.
Increases in the partner’s share of partnership liabilities generally are treated as cash contributions by the partner, while decreases are treated as cash distributions to the partner. Complex rules govern the allocation of liabilities to partners.
Outside basis adjustments are required on the date that contributions of property are made.
And, likewise, adjustments are generally required on the date that distributions take place.
There is an important exception for distributions that are merely advances or drawings against a partner’s distributive share of income for that year: these are treated as current distributions made on the last day of the partnership’s taxable year.
But, to answer your question: ... And this is a LITTLE different from the way you expressed it, it's not that it stops at zero each year ... It's NEVER reduced below zero
See this, from AICPA:
The partner’s initial basis is determined pursuant to Internal Revenue Code1 sections 722 or 742 depending on how the partner acquired the interest (i.e. by contribution or by acquisition). First, the initial basis is increased under section 705(a)(1) for (a) subsequent contributions, and (b) the partner’s share of the partnership taxable and tax-exempt income. Then, the partner’s basis is decreased under sections 705(a)(2) and (a)(3) by (a) the amount of cash distributions and (b) the adjusted basis of any property distributions. The partner’s outside basis is further reduced by the partner’s share of the losses and non-deductible/non-capital expenses. Outside basis is never reduced below zero.
1 All references to the word “section” in this guide reference the Internal Revenue Code unless otherwise noted.
Sory for the data dump, but I wanted to give this to you context, and give you something for the files
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