Application of the Tax Basis and At-Risk Loss Limitations to Partners

     Individuals who invest in partnerships need to be aware of the rules that limit the ability of a partner to deduct losses.  Individual partners who have been allocated a distributive share of loss must satisfy three separate loss limitations before the loss can be used.  The loss limitations, in the order in which they are applied, include:

   1)      The Sec. 704(d) basis limitation,

   2)     The at-risk limitation of Sec. 465, and

   3)     The passive loss limitation of Sec. 469. 

     Loss Limitation under Sec. 704(d) provides that a partner’s distributive share of loss is allowable to the extent of the partner’s adjust tax basis in his interest in the partnership at the end of the partnership year in which the loss occurred.  Any losses in excess of the partner’s tax basis are disallowed pro rata and are carried forward indefinitely for as long as the partner remains in the partnership.

     Sec. 705(a) generally provides that a partner’s adjusted basis in his interest in the partnership includes the amount of money and the adjusted basis of property contributed to the partnership increased by any gain recognized on the contribution.  A partner’s adjusted basis is increased by the partner’s distributive share of taxable and tax-exempt income and decreased by the partner’s distributive share of partnership losses, nondeductible expenditures, and the amount of money and the adjusted basis of distributed property.

     A partner’s basis is further adjusted by the liability allocation provisions of Sec. 752.  Sec 752(a) provides that an increase in a partner’s share of the partnership’s liabilities, or an increase in a partner’s individual liabilities because the partner assumed those liabilities, is considered a contribution of money by the partner to the partnership.

March 2012 The Tax Advisor

Article: “Tax Clinic” by Jon Almeras, J.D., LL.M.