1065 K-1 box 19c

[krazykev]

I'm flummoxed by a K-1 issue from a client and would appreciate any assistance that could be offered by the members here. Client's father gave her an interest in his business limited partnership (form 1065) in 2010 as a limited partner. In 2011, the K-1 reflects a box 19C distribution of close to half a million dollars. According to the preparer (CPA) of the 1065 and K-1, this distribution was "an adjustment between 3 companies for stockholder debt" and he "sees no tax implications" related to this transaction. Client's father operates a trucking company as an S Corp, truck leasing company (limited partnership in question) and evidently other entities that I know nothing about.

The basis provided by the same CPA for the gifted ownership in the partnership was zero (actually negative, but basis can't be negative) at the beginning of 2011 and the partnership had a box 1 income of $90k and a box 3 loss of $90k. So it appears that there is insufficient basis after the distribution so the loss would be suspended and the $90k in income taxable. No information is provided in box K for partner's share of liabilities.

I've not dealt with limited partnerships and limited partners before. So I guess my questions are (1) does a limited partner have debt basis? (2) would a "distribution" for an adjustment of debt between stockholders result in a suspended loss from box 3 and taxable gain from box 1, a capital gain related to distribution in excess of basis, or both? (3) does it sound reasonable what CPA has done for this transaction?

Any advice would be greatly appreciated! Thanks!!

[Bees Knees]

Schedule K-1, line 19C instructions:

Code C. Other property. Code C shows
the partnership’s adjusted basis of property
other than money immediately before the
property was distributed to you. In addition,
the partnership should report the adjusted
basis and FMV of each property distributed.
Decrease the adjusted basis of your interest
in the partnership by the amount of your
basis in the distributed property. Your basis
in the distributed property (other than in
liquidation of your interest) is the smaller of:
•The partnership’s adjusted basis
immediately before the distribution or
•The adjusted basis of your partnership
interest reduced by any cash distributed in
the same transaction.

Since this is not a cash distribution, there is no tax on the distribution. The taxpayer reduces basis in the partnership by the basis of the distributed property. If the taxpayer’s basis in the partnership is zero prior to the distribution, then the basis of the distributed property is zero to the partner after the distribution. Thus, if the distributed property is some kind of debt adjustment, this partner receives zero basis in it.

[krazykev]

Thanks for the reply.

I'm not worried as much about the distribution being taxable as I am the "distribution" putting the box 3 loss as suspended but the box 1 income is taxable. According to both my software and TaxBook adjusted basis worksheet, the box 1 $90k is taxable and the box 3 $90k loss is suspended due to the ordering rules.

However, I am hoping that since the distribution wasn't an actual distribution of cash or property that it won't reduce the basis and suspend the loss. This is where I'm lost.

[Bees Knees]

I don’t see how TTB Partnership Basis worksheet causes the line 3 loss to be suspended. The worksheet merely puts the K-1 loss and the property distribution in the same category. It does not specify any ordering rules.

According to Pub 541, page 4, a distribution isn’t taken into account until the last day of the year. That to me means you net all other K-1 transactions first before determining the tax consequence of a distribution.

[krazykev]

I guess it boils down to the fact that the "distribution" is not an actual receipt of cash or property. According to all my research if these distributions were cash or property then I think my interpretations would be correct and not only would there be a gain on the excess distribution, but the box 3 loss would be suspended and not netted with the box 1 gain. My line of thought comes from my software calculation that is backed up by:

Revenue Ruling 66-94, 1966-1 C.B. 166 – Distributions are taken into consideration before losses in computing a partner’s adjusted basis in the partnership interest under IRC section 704(a).

Thus, if the distributions eliminate any remaining basis, then the loss is suspended. If you follow the TTB Partner's Adjusted Basis Worksheet the loss from box 3 isn't added in until line 13 after the basis has been reduced to zero following the distributions on line 11 so according to the bottom at line 19 "the loss is suspended until basis increases" which is that same that Rev Ruling 66-94 lines out.

I still see this issue as a huge audit flag and fear that this creative accounting approach may come back to bite us down the road. It may be resolvable in my client's favor after pulling the 1065 and an audit but it won't be pretty. I don't disagree that the distribution isn't taxable and the loss isn't suspended, I just don't fell real comfortable that there is a lot of concrete data to back up this approach.