Types
of Basis
If you want to avoid paying more tax than you should it is important
that you know the difference between OUTSIDE and INSIDE basis.
To understand the taxation of partnerships and distributions,
it is necessary to know the 2 types of tax bases concerning partnerships.
The inside basis is
the partnership's tax basis in the individual assets.
The outside
basis is the tax basis of each individual partner's interest in the
partnership.
When a partner contributes property to the partnership, the
partnership's basis in the contributed property is equal to its fair market value (FMV) – inside basis. However, the
outside basis is generally the amount of the basis that the partner had in the
property.
Here
is an example:
You contribute land to a partnership with a tax basis of
$10,000 and a FMV of $50,000. Your other partner contributes $50,000 cash.
Since the FMV of the land is also $50,000, you each have equal equity in the
partnership, and the total inside basis of the partnership is equal to
$100,000, your combined contributions. However, your outside basis differs from
your partner's, since your outside basis is $10,000, while that of your
partner's is $50,000. If you sold your partnership interest for $50,000, you
would recognize a gain of $40,000, whereas your partner, if she sold at the
same price, would recognize no gain. Got it?
Property Distributions
When property is distributed to a
partner, then the partnership must treat it as a sale at fair market value
(FMV). The partner's capital account is decreased by the FMV of the property
distributed. The book gain or loss on the distribution (which is called a “constructed
sale”) is apportioned to each of the partners' accounts.
Generally, there are no tax
consequences of a current property distribution — there is never a taxable gain
or loss, either to the partnership or to the partner.
The partnership's inside basis of
the property carries over to become the partner's basis, thereby reducing the
partner's outside basis by the carryover basis.
As with the cash distribution, if
the FMV of the property exceeds the partner's outside basis in the partnership,
then the partner's interest in the partnership is reduced to 0 and the
receiving partner's basis in the distributed property equals his outside basis
in the partnership before the distribution. The property basis that remains
after subtracting the outside basis is taxable as a gain.
Here is a property distribution example.
Let’s
say your adjusted basis in a partnership is $14,000. You receive a distribution of $8000
cash and
land with a FMV of $3000 and an adjusted basis
of $2000.
Since the amount of cash received is less than your interest in the
partnership, there is no taxable transaction. However, your outside basis in
the partnership declines to $4000 (= $14,000– $8000 – $2000). Subsequently, you receive a
distribution of land with an adjusted inside
basis of $10,000.
Since your outside basis in the partnership is only $4000, your adjusted basis in the land is
also $4000, and you must report a gain of $6000 (= $10,000 – $4000). Got it?
Definitions:
Adjusted Basis or Adjusted Tax Basis refers to the original cost or other
basis of property, reduced by depreciation deductions
and increased by capital expenditures.
Example: Brad buys a lot for $100,000. He then erects
a retail facility for $600,000, and then depreciates the improvements for tax
purposes at the rate of $15,000 per year. After three years his adjusted tax
basis is $655,000 [$100,000 + $600,000 - (3 x $15,000)].
Carryover basis is a method for determining the tax basis of an asset when it is transferred
from one individual to another.
At
John L Mottram CPA LLC
Certified Public Accountants we can make sure that you and
your partners are always up-to-date on the inside and outside tax basis in your
partnership capital accounts. Email, phone or text John Mottram CPA at jlm@mottramcpas.com,
214-543-1855 and let us start the process of better understanding.
