Partnership interests require careful recordkeeping Tax Matters by David A. Katzman If you have a financial interest in a business, which is organized as a partnership, your “basis” may be frequently adjusted, so you will need to take extra care to keep appropriate records and maintain ongoing tracking of your basis. A basis, for tax purposes, is each partner’s interest in the business, similar to a shareholder’s basis in a corporation. For corporate shareholders, excluding S corporations, tracking basis is simple. A shareholder’s basis is the initial cost of the stock. To determine gains or losses, the initial cost is subtracted from the current cost-per-share. For example, if a shareholder paid $1,000 for 100 shares, the per-share basis would be $10. If the 100 shares were sold for $2,000, the shareholder would subtract $1,000 from the total and pay taxes on gains of $1,000. In a partnership, tracking your basis is much more complicated because it adjusts. These frequent adjustments make recordkeeping vital. Your adjusted basis will impact gain or loss upon the sale of your partnership interest, impact how partnership distributions are taxed and impact the maximum amount you are allowed to deduct in the event of a partnership loss. Initially, your partnership basis is determined by value. If you buy into a partnership, the amount you pay is your beginning basis. If you also contributed property to the partnership, the cost basis of this property will be included when determining your beginning basis. If you contributed services, and your partnership interest in not simply a profits interest, then the value of the services provided is taxable income to you and then deemed contributed to the partnership to establish your beginning basis. For example, if you contributed $50,000 in cash and another $50,000 in cost basis of property or value of services to a partnership, your beginning basis is $100,000. There are two basic times when your basis will adjust. The first is on the last day of the partnership’s tax year and the other is when contributions or distributions are made. Your partnership basis will either increase or decrease on the last day of your partnership’s tax year when your share of income or gains, or your share of losses, ordinary or capital, are distributed to you. Your basis will also either increase or decrease any time a contribution or a distribution occurs. For example, if you contributed additional cash or property to the partnership, you basis will increase by the amount of those contributions. Likewise, your basis will decrease by the amount of any cash or property distribution you receive from the partnership. Any losses cannot decrease your basis to below zero. If you experience the full loss of your partnership interest, your maximum possible deduction is the full amount of your then adjusted basis. You are not allowed to deduct any amount that would reduce your basis to less than zero. If your partnership relies on borrowing, your basis will increase or decrease each time the amount of your partnership’s indebtedness changes. If your partnership assumes additional debt, this is treated as a cash contribution to the partnership and your basis will increase by the amount apportioned to your partnership share. When you make repayments, and your share of the partnership’s debt decreases, this is treated as a cash distribution and your basis will decrease accordingly. The type of borrowing the partnership assumes determines the amount of your basis increase or decrease. If the loan is recourse debt, your basis would generally increase by the amount that you, as a partner, would have to pay to satisfy the debt if the property securing the loan became worthless. For nonrecourse debt, there is more flexibility, but generally your basis would change based on your profit percentage, after accounting for required allocations reflecting earlier deductions. Depending on the type of partnership and its level of activity, your basis could change frequently, so close tracking of all transactions is essential. If you need assistance determining these adjustments, a tax professional can provide specifics based on your personal circumstances. David A. Katzman is a certified public accountant licensed to practice in the State of Florida and the Commonwealth of Massachusetts. He is also a certified financial planner and certified senior advisor. Please consult your tax advisor for details and assistance in applying this general information to your specific situation.