Perhaps I'm confusing S-Corp rules with partnership rules ...or perhaps just because it's Friday. I have ONE partnership client which is the bane of my existence every year.

Facts:
In 2004 TP suffered a casualty loss due to a natural disaster.
In 2005 TP sold it's assets (capital a/c's went negative - remaining liab's at end of the year enough to cover negative capital a/cs plus a little bit more )
In 2006 TP received some unexpected insurance proceeds (postponed gain). TP also incurred some expenses and paid some of the old liabilities causing neg cap a/c's to exceed basis. TP also distributed some $$ to members (small)
In 2007 TP unexpectedly won its bad faith lawsuit against its insurance company (at this point TP expects 2007 to be final year if suitable replacement isn't found).

I'm working on the '06 now. Do I have some cap gain for the amounts that exceed basis (Inside basis is less than outside basis)? Or because it's a small amount can I just wrap it all up next year with the final TR (when all old liabilities will be wiped out all together)?

Also I was wondering, can partners with negative basis deduct current year losses? I know in an S-Corp you can't until basis is restored. However, is it the case with partnerships?

I didn't think you could, 'but the software is allowing it' which causes me to pause.

I would greatly appreciate anyone's input on the matter.

Thank you in advance.