Confussed by Info on K-1

[Bonnie]

I only do individual returns and do not prepare 1065 or 1120 returns so I'm hoping someone who does can enlighten me a little about info on the K-1 my customer received. I've tried talking with the accountant who prepared the 1065 but still cannot understand the info on this K-1. Box 1 has -3132, Box 2 has 2761, box 10 is -414 and in box 14 as self employment is -3132. I'm trying to wrap my head around all this and prepare the 1040 for my customer. The nature of the Partnership is residential rental property. 3 individuals own around 12 properties. The accountant told me the 2761 in box 2 is the net rental income for these properties after preparing individual returns for each property. There is an attachment that lists each property and the income or loss from each. The -3132 in box 1 is the net loss of the business after other expenses not associated with any individual rental property. If I enter all this info the business loss of 3132 does not flow because the income of 2761 is also calculated into this business. Wondering if this amount in box 2 is for information purposes only and should not be entered into the tax program. Also I question the amount in box 14 of -3132 for self employment. To me it seems odd to have a loss in this box. My customer is also self employed himself and files a Sch C for his business. This loss on the K-1 for self employment flows thru to his SE form and reduces the amount he is paying SE tax on. Doesn't really seem right to me, but since I don't prepare K-1s would like someone elses input.

[Kram BergGold]

What it sounds like to me

The partnership is a business unto itself and shows a loss so SE loss goes with it.
The partnership's rental properties show positive income.
In the two software programs I have used you must enter line 1 info on one K-1 input screen and line 2 on another. Try that.

[Bonnie]

Well I can enter it but my concern is that I have this negative 3132 and when I enter the 2761 of income it subtracts from the negative number thus the net loss would only be 377 yet under self employment it does show this loss of 3132.

[appelman]

This is a common situation for real-estate partnerships.

The problem is that line one is non-passive, while line 2 is passive, and not all software can handle it. If you follow Kram's suggestion and use one K-1 for the non-passive loss and another for the passive income, checking various boxes appropriately, everything should come out fine. The passive income will not and should not net against the non-passive loss. What software are you using?

[Bonnie]

Using Tax Slayer and not a problem with the software, it allows me to do this. Just trying to sort it out in my head. I like to understand what I'm doing and in this case kinda don't understand what's happening. Mostly because it seems not a true indication of the business loss becasue the 2761 in box 2 seems like it's also already included in box 1. The software handles all this. I just want to understand it and I don't. If I prepared the K-1 I might get it but I don't do those returns.

[Lion]

Imagine box 1 as a schedule C and box 2 as a schedule E. You would not net those two schedules together. You would have SE tax on the C income only and not the E. If you had two schedules C, you would include both on schedule SE.

[Bonnie]

Thank you Lion, now that makes sense to me and I think I understand now.

[Lion]

Way simplified and just a starting point, but you can picture that separate entity that has an activity that will net with any other SE income plus the rental activity that is defined as passive and does not net with SE income.

[Gary2]

The problem is that line one is non-passive, while line 2 is passive, and not all software can handle it. If you follow Kram's suggestion and use one K-1 for the non-passive loss and another for the passive income, checking various boxes appropriately, everything should come out fine. The passive income will not and should not net against the non-passive loss. What software are you using?

While it's commonly the case that line 1 is non-passive and line 2 is passive, the classification into passive and non-passive activities is done at the individual level, not the partnership level. One partner might satisfy the material participation requirements to take a loss on the rental side, while another partner might not, and vice versa for the general business activities.

Which leads me to the underlying question that people are sidestepping. Is the reporting of the loss on line 1 correct? The fact that an expense isn't related to an "individual rental property" doesn't tell me that it's not related to the rentals at all. An expense that's general to all of them needs to be allocated among the properties, and not just reported on line 1. Conversely, line 1 expenses are usually related to activities that are considered a business, i.e., those that would go onto a Sch. C if it were a sole proprietor (as Lion points out). So the question is, what Schedule C-type activity is there?

I'm not saying the K-1 is wrong. Among other things, I'm not sure how something like amortized organizational expenses would be reported, particularly if there's a real mix of line 1 and line 2 activities. But regardless of whether the K-1 is right or wrong, I think you need to find out enough about that entry to determine whether or not it's passive. You can't simply assume it's not. The Form 1065 instructions include several pages specifically on the reporting of potentially passive activities.

[Kram BergGold]

Line 1 could be passive

Why are some of you assuming line 1 is non passive? If the Taxpayer is a limited partner, then both lines 1 and 2 are passive by definition. If the partner is a general partner, then the material participation tests need to be looked at to determine non passive.

[Uncle Sam]

Confussssssssed

I concur with Kram -
I have clients who are limited partners of all sorts of partnerships who have amounts shown
on Line 1 of K-1.
I have to code the computer that it's a passive investment activity for proper calculations.

You need to look at the boxes checked for the type of partner to determine if passive or not.

[appelman]

Box 14 = Box 1!

This tells me that it is not a limited partner and that, at least in the eyes of the preparer of the 1065, this is non-passive income. You can always try to second guess the K-1, but that makes a whole new ballgame.

[Gary2]

This tells me that it is not a limited partner and that, at least in the eyes of the preparer of the 1065, this is non-passive income. You can always try to second guess the K-1, but that makes a whole new ballgame.

The standard for self-employment tax is not the same as the standard for non-passive income. Self-employment tax applies to all business income of a general partner. The passive activity rules hinge on material participation. Thus a passive general partner (uncommon, but possible) can have self-employment tax on passive income.

[appelman]

"Uncommon" is the operational word, I would say.

But if you're really in doubt, you can always check with the preparer of the 1065 or the tax matters partner of the partnership.

[Gary2]

But if you're really in doubt, you can always check with the preparer of the 1065 or the tax matters partner of the partnership.

Let me rephrase it. It's uncommon to have a passive general partner when there's only one activity, particularly since the advent of LLCs make it easier to get limited liability for independently of level of participation. However, when there's more than one activity - which seems to be the case here - I won't speculate as to how common it is. I'll just point out that with multiple activities, it's doesn't seem extraordinary that someone would have to be a general partner without material participation in every one of those activities.

In theory, it shouldn't be necessary to contact the preparer or tax matters partner. The 1065 instructions say, in the Passive Activities Reporting Requirements section, that the K-1 should include an attachment identifying each activity. All we were told here, in the base note, is that the box 1 income was not rental real estate expenses. There should have been a statement identifying what it was, not what it wasn't.

And yes, I'm still suspicious that this was an improper attempt to make a passive loss have the appearance of a non-passive loss, perhaps due to misunderstanding rather than willful evasion.