How JustAnswer Works:
  • Ask an Expert
    Experts are full of valuable knowledge and are ready to help with any question. Credentials confirmed by a Fortune 500 verification firm.
  • Get a Professional Answer
    Via email, text message, or notification as you wait on our site.
    Ask follow up questions if you need to.
  • 100% Satisfaction Guarantee
    Rate the answer you receive.
Ask Dr. Fiona Chen Your Own Question
Dr. Fiona Chen
Dr. Fiona Chen, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 482
Experience:  Former IRS Revenue Agent
72280797
Type Your Tax Question Here...
Dr. Fiona Chen is online now
A new question is answered every 9 seconds

I have a 2 partner (M & E) partnership 50/50. In this final

Customer Question

I have a 2 partner (M & E) partnership 50/50. In this final year M will be distributed cash of $16,900 and rental property of $440,000 (NBV) with a related mortgage of $510,000. M will end up with a positive equity balance of $143,100 and E will end up with a negative equity balance of $143,100. I believe E will need to report a LTCG of $143,100. Normally M would continue on with the basis on the rental of $440,000 where the partnership left off. What I don't know is how to treat the positive equity balance of M on his taxes. Does he have a LTCL or does his equity balance get added to the NBV for a new basis going forward of $583,100?
JA: The Accountant will know how to help. Is there anything else the Accountant should be aware of?
Customer: No
Submitted: 10 months ago.
Category: Tax
Expert:  Dr. Fiona Chen replied 10 months ago.

Dear Accountant,

For some reason the partnership allows the current or final year partners' bases to become one with +143,000 and one with -143,000. Then, the partnership is automatically dissolved because there is a one 100% owner and the other to be 0%.

Provided that the above is true, let me answer your question on Partner E.

Partner E's outside basis needs to be calculated from year one. It is not assumed that s/he has a long term capital gain. This calculation needs to be done from year 0 and 1.

As to Partner M, his/her basis needs to be calculated from year 0 and 1, too. The conclusion cannot and should not be drawn based on the last year activity. With this year's information, s/he is actually with a loss. That is a liability of 510,000 minus the rental property value of 440,000. That is minus, -70,000. S/he got a liability. Then, this amount is somehow compensated with cash of 16,9000, which brings his/her negative distribution to -53,100.

So, Partner M got a negative -53,000 in the form of mortgage liability. From surface, as we can see here and now, there is no gain for him/her.

Please feel free to follow up with question. Otherwise, I am ready to be evaluated by you for your satisfaction with my answer to your question.

Regards,

Fiona Chen, MPA, PH.D., CPA, ABV, CFF, CITP

Customer: replied 10 months ago.
There is no difference between book equity basis and outside basis. E has accumulated the large negative equity balance due his share of prior years operating losses. This pass through was allowed due to his share of the recourse debt. Since he recognize the losses in prior years I believe he has LTCG on his final negative balance. I don't know if M can claim a LTCL or if he needs to increase his basis in the rental property.
Expert:  Dr. Fiona Chen replied 10 months ago.

Dear Accountant,

In terms of Partner E,

If both partners were 50/50, their beginning bases should be the same for this year. Which apparently is not the case.

But let us assume the past does not matter and by the end of the year, Partner E has a -143,000 basis in the business, this closed partnership. If he has taken all the rental loss in his tax return, what made you think that he has a long-term capital gain for this year?

He did not get anything. A negative basis does not turn around to become a long-term capital gain. Do I miss any information here?

For example, each year I lost 20,000 in my business. By the end of 6 years, I have flow through loss accumulated 120,000. Yes, my basis is negative in this business, and the flow through makes me recognized losses on my personal tax return accumulative 120,000 in six years. Where do I have a gain to start with, long or short term?

Regards,

Fiona

Customer: replied 10 months ago.
Per IRC 465 losses taken under the at-risk rules due to the recourse debt need to recognized as income when the negative capital account is not paid back to the partnership at termination.
Expert:  Dr. Fiona Chen replied 10 months ago.

Dear Accountant,

1) Do you mean like half of the 53,000 mortgage loan forgiven he got this year?

Debt forgiven needs to be reported in the current year as the regular income. It cannot be carried over to the future or next year. It is not long term.

2) We should never allow the partner become negative in basis in comparison to other partners. If that becomes the case, normally, the other partners will allow this partner to recognize more income to let him/her come back above the 0 level. Otherwise, this person is out. There is no such partner any more.

3) As to this case, if there was any debt forgiven he had before, in that particular year, he should have recognize regular income.

4) Basis calculation is important in terms of outside basis. When a person (partner) has distribution or debt forgiven causing him to have more than his basis, s/he needs to recognize regular income in the current year. These type of items cannot be carried over.

5) Dividends has the concept of long and short term capital gain. Partnership and S Corporation activities flow through are current year regular income/loss as recognized through Schedule E on the first page of Form 1040.

Regards,

Fiona

Customer: replied 10 months ago.
The mortgage company has not forgiven any of the debt. Partner M will be assuming the debit. Both the debt and the rental property are being distributed to M through his equity account. Over the years M has contributed money to support the bank account and E has not contributed any additional cash. Again due to the at risk rules E has been able to recognize losses in excess of his basis. Unless you have some thoughts we are just going agree to disagree.
Expert:  Dr. Fiona Chen replied 10 months ago.

Dear Accountant,

What are we disagreeing? The long term capital gain? There is no long-term capital gain unless the partnership is sold. For example, if the partnership is not ended this year, will Partner E continue to carry his/her negative basis to next year?

If from one year to next, in the past, the two partners' contributions and distributions and bases have been different, they were not 50/50 partners long time ago.

At the end of each year, when the individual partners reporting their income, on their own 1040, the K-1's bases need to be reported based on the partner's own bases. Therefore, there would be gain reported if the partner's distribution and debt forgiven make him/her have regular income.

This needs to be a yearly event and cannot be carried to next year forever.

Regards,

Fiona

Expert:  Dr. Fiona Chen replied 10 months ago.

Dear Accountant,

I am going to attach several sources for your references. Further investigation is always good for our profession. This topic apparently worth further investigation.

1. IRS audit technique guide for partner's inside and outside bases

https://www.irs.gov/businesses/partnerships/partnership-audit-technique-guide-chapter-3-contribution-of-property-with-built-in-gain-or-loss-irc-section-704-c-revised-12-2007

2. Publication 941, you probably already know

https://www.irs.gov/publications/p541/ar02.html

3. IRS Practitioner's Hotline number.(###) ###-#### ***** first choice is tax law question. Because you have an active taxpayer case, they will be glad to talk with you. They will have someone pre-screen our question first. Then, decide on whom to give to us to talk with. Sometimes, we get someone who is really good. Sometimes, it may not be the person's specialty. There was once I had an employee plan specialist calling me back like after I place the question for one week. You don't have to tell them the taxpayer information when you are asking the tax law question.

4. IRS held tax forums are held in major cities each year. The registration is relatively cheap. If you attend and ask around, it is likely that you will get nationally known experts on the subject. Otherwise, someone will introduce you to others to help us to get the questions answered. That is the purpose of the forum to help the professionals.

5. Find IRS rulings, private rulings on the subject. The authors are attorneys. They are also called, "the national counsel on the subject (IRC Code)." If there are things they don't know, they will research and get back to you. Most of the times, they can find resources for us right a way. This is not something we use all the times. But when we have definitely hard and strong questions, they are the resources we go to. A lot of times, the counsel's name and telephone numbers are placed in the end of the ruling. The reason for their contact information to be right there is for the practitioners to contact them on the subject. These counsels are usually located in Washington, D.C., they are very helpful.

6. Of course, when we are really not sure and the case is relatively important to us, we can always send in request for the IRS to give us private ruling letters.

Hopefully, these resources can help us answer difficult and specific questions. It is nice to have the discussion with you. Keep up with the good work.

Regards,

Fiona

Expert:  Dr. Fiona Chen replied 10 months ago.

Dear Accountant,

I am looking at your original question.

Your question was on how to treat the positive balance of M on his taxes. For M, the partnership will be dissolved. He is the owner of this rental property which from now on will be reported on his Form 1040 tax return Schedule E as rental property. If he has had a positive basis, i.e., say 583,000, say this is true, he does not have a tax issue in terms of 583,000. positive basis. The partnership dissolved. Assume that he has reported tax on his tax return. Therefore, there is no tax issue for this positive basis. He does not carry this basis forward any more. It is done.

Hopefully, this part answers your questions. The other discussions a sort of distract from your main question. Hope now, it is cleared up.

Regards,

Fiona

Expert:  Dr. Fiona Chen replied 10 months ago.

p.s. My answer to M's tax return responsibility is based on the information that all prior years were correct. And previously I calculated his bases on this newly assumed rental property for this year. That number does not have the issue on depreciation taken prior to this year, etc. Therefore, s/he personally has a basis on the property. His/her personal possible loss or gain on the business is a different issue. They do not come from his.her inside bases but from his/her outside bases. Nevertheless, all these discussions above are assumed that prior year tax liability and calculations were correct.

Regards,

Fiona

Related Tax Questions