Negative Partnership Basis (Inside & Out)

[TaxBird]

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.

[Joe Btfsplk]

Partnership

This does not seem to be covered in The Tax Book. Since it is so explicitly covered for S-Corps, that would lead me to believe a loss in excess of basis could be passed thru.

Another point would be the unlimited liability of partners. His losses in excess of his basis would tend to increase his liabilities.

The "at risk" rules would seem to be the main consideration. For an LLC there could be nonrecourse liabilities which would tend to make a passive investor unable to deduct losses in excess of his basis.

Check the at-risk publications from the IRS and you might find something specific that would answer your question more authoritatively.

[Bird Legs]

Taxbird-Try

Googling. Go to Google and type in "negative partnership basis" and see what pops up.

[Golden Rocket]

TaxBird

from your post, you illustrate alternative terminologies of "basis" and "capital accounts."

Even "Inside basis" is not the same as capital accounts, although it grows and shrinks with profits and losses. Neither "Inside" basis nor capital accounts are criteria used when deducting losses, the measuring stick must be the partner's basis.

My general feeling is that at no point during this four-year odyssey should the partner's capital account be less than zero. Remember also that the partner's share of liabilities are added to his basis, and this will clearly not be the case for capital accounts, nor is it allowed for S corps. Inclusion of liabilities in a partner's basis often salvages the deductibility of a loss.

This post probably has done little to provide you with an answer to your question, but it might be helpful to re-read TTB 20-6 and the ensuing couple pages.

Good luck. It sounds like a very interesting client who really needs some expertise.

[TaxBird]

Thanks to all who replied

As I mentioned, this partnership (LLC taxed as p-ship) has been the bane of my existence since the '04 casualty. The complexities of it fries my brain every year. However, it is my last 'corporate' and I will be glad when it's done. I'll be even happier when I click the 'final' box on the '07.

I was not looking forward to reading code all weekend but here I go.

Thanks again

[TaxBird]

Heh heh

Ok False alarm.

Basis is NOT negative.

Someone must have slipped me a mickey.

heh heh

*sigh*