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Are you a partner at an LLC or other company based in the Columbus, Ohio area? Do you understand partnership basis and the importance of tracking it? In the article below, the Columbus-based McGuire Law Firm explains the importance of keeping track of partnership basis so as to better understand tax liabilities upon sale, transfer, or liquidation.
Partnership Basis and the Importance of Tracking Partnership Basis
It is very important for Columbus business owners to understand their basis in their ownership interest and how such value can impact their tax consequences upon the sale or transfer of their ownership interest. This article below has been prepared to discuss a partner’s basis in their partnership interest such as a limited liability company.
Similar to how an individual’s basis in a share of Microsoft stock is important in determining the gain or loss upon the sale or transfer of that stock, a partner will have a basis in their partnership interest and such basis in their partnership interest is used and applied in determining the gain or loss after the partner sells all or a portion of their partnership interest, or certain tax consequences upon the liquidation of the partnership. For example, if a partner is planning to sell their membership interest in a limited liability company for $1M, with a basis of $0, the partner would recognize $1M of gain, or, with a basis of $500,000, the partner may only recognize $500,000 of gain.
What Is a Partner’s Basis Upon Contributing Cash or Property?
When a partner acquires their partnership interest via a contribution of cash and/or property to the partnership, their partnership basis is the sum of the money contributed and the adjusted basis of any property contributed. What if a partner contributes a promissory note? The contribution of a promissory note by a partner will not increase the partner’s basis. This is due to Internal Revenue Code Section 722, holding that the partner will have a basis of zero in the note.
When Can a Partner Use a Loss or Deduction From the Partnership?
A partnership is a pass-through entity. When losses or deductions are passed through at the partnership level to the individual partners, a partner’s distributive share of the loss or deduction is deductible only to the extent of their partnership basis at the end of the taxable year under Internal Revenue Code Section 704(d). Thus, a partner without sufficient or enough basis may not be able to claim any or all of a pass-through loss because of their basis. That being said, it is important to note that if a partner has disallowed losses, the losses can be carried forward until a later point in time when the partner has sufficient basis to take the loss, which is stated under Treasury Regulation 1.704-1(d).
Is A Partner’s Basis Adjusted As The Partnership Operates?
A partner’s basis within a partnership is adjusted as a partnership operates and items of income or losses are distributed or allocated to the partner. A partner’s basis will increase under Internal Revenue Code Section 705 by the sum of the distributive share for the taxable year and prior taxable years for the following items: taxable income to the partnership; income of the partnership exempt from tax; the excess of the deduction for depletion over the basis of the property subject to depletion; and, additional capital contributions. A partner’s basis will decrease under Internal Revenue Code Section 705(a)(2) (but not below zero) due to distributions from the partnership (these distributions could be distributions of cash and/or property to the partner) and by the sum of the partner’s distributive share for the taxable year and prior taxable years for losses of the partnership and non-deductible expenditures of the partnership in computing taxable income & not properly chargeable to capital (such as meals & entertainment).
When individuals are forming a partnership and contributing money and/or property to the partnership, it is highly advised that the partners or the partnership consult with a tax attorney regarding the importance of basis and adjustments to their basis. A partner’s basis will “follow” the partner and thus it is crucial to correctly and accurately track each partner’s basis, and furthermore for the partners to understand how certain transactions and distributions will impact and change their basis.
Discuss Partnership Basis With A Tax & Business Attorney
The tax and business attorneys at The McGuire Law Firm can assist Columbus area partnerships and the partners of the partnership regarding partnership transactions and partnership issues including formation of the partnership, contribution of property, partnership taxation, allocation of partnership income and losses, the purchase or sale of partnership interests and other tax matters.
If you are a business owner or partner in the Columbus, Ohio area and want to discuss partnership basis with a seasoned professional, reach out to The McGuire Law Firm today to schedule an appointment.