Study Unit 10: Partnership Operations

All of the following items must be separately stated on the partnership’s Schedule K (Form 1065) and included as separate items on the partner’s return EXCEPT

• Ordinary gains and losses from Form 4797, Part II.

  
  

• Gains and losses from sales or exchanges of capital assets.

  
  

• Guaranteed payments to the partners.

  
  

• Interest income.

  
  

Answer explanation

Each partnership item of income, gain, deduction, loss, or credit that may vary the tax liability of any partner (if reported separately on the partner’s personal return) must be separately stated. Items that must be separately stated include the following: (1) Sec. 1231 gains and losses; (2) net short-term and net long-term capital gain or loss from the sale or exchange of capital assets; (3) guaranteed payments; (4) interest and dividend income; (5) royalties; (6) tax-exempt income and related expenses; (7) investment income and related expenses; (8) rental activities, portfolio income, and related expenses; (9) cancellation of debt; (10) recovery items (e.g., prior taxes, bad debts); (11) charitable contributions; (12) foreign income taxes paid or accrued; (13) depletion on oil and gas wells; (14) Sec. 179 deductions; (15) distributions; and (16) qualified items of income, gain, and loss for the qualified business income deduction (QBID) (Publication 541, Form 1065 Schedule K, and the instructions to Form 1065).

Comfy Chairs Manufacturing, Ltd. operates as a partnership and files Form 1065. Comfy manufactures inflatable lounge chairs. During the current tax year ended December 31, Comfy generated income and expenses as stated below. What is the correct amount of ordinary income (loss) from trade or business activities Comfy should report on Schedule K for the current year?

Employee wages $15,000

Income from rental real estate 20,000

Charitable contributions   500

Cost of goods sold 10,000

Income from chair sales 75,000

• $65,000

  
  

• $69,500

  
  

• $50,000

  
  

• $30,000

  
  

Answer explanation

Included in the partnership’s ordinary income are such items as gross profit on sales, administrative expenses, and employee expenses. Thus, income from chair sales, employee wages, and cost of goods sold are included in ordinary income to give $50,000 ($75,000 – $15,000 – $10,000). Charitable contributions and income from rental real estate have to be separately stated. Ordinary income is different from partnership taxable income in that partnership taxable income is the sum of all taxable income items, including separately stated items and ordinary income items.

On January 1, 2021, Thomas contributed real estate he held for investment to Fog Partnership, a dealer in real estate. The real estate had an adjusted basis to Thomas of $50,000 and a fair market value at the time of the transfer of $43,000. On June 1, 2023, Fog sold the real estate for $40,000. What are the amount and the character of the partnership’s loss?

• $3,000 capital loss; $7,000 ordinary loss.

  
  

• $7,000 capital loss; $3,000 ordinary loss.

  
  

• $10,000 ordinary loss; $0 capital loss.

  
  

• $10,000 capital loss; $0 ordinary loss.

  
  

Answer explanation

The partnership’s basis in the property was $50,000 under Sec. 723. The loss realized and recognized on its sale was $10,000 (Sec. 1001). If property is contributed that would have generated a capital loss if sold by the partner, a loss on the disposition of the property within 5 years of its contribution is a capital loss [Sec. 724(c)]. The amount of the loss characterized as capital is the $7,000 amount of capital loss the contributing partner would have recognized if (s)he had sold the property on the contribution date ($50,000 – $43,000). The remaining loss has the character it would have to the partnership.

Partner C invested $30,000 cash for a 60% interest in ABC Partnership. C materially participates in the partnership’s business, and the partnership agreement states he is liable for all of the partnership’s debts. The only partnership debt at the year end was a $15,000 loan from Book Bank. Partner C and the other general partner had a separate agreement that C’s liability would not exceed $10,000. The partnership reported a $70,000 ordinary loss for the year. What is the amount of C’s deductible loss?

• $40,000

  
  

• $42,000

  
  

• $45,000

  
  

• $70,000

  
  

Answer explanation

A general partner’s basis in his or her partnership interest is increased by his or her share of the partnership’s recourse liabilities for which (s)he is ultimately liable [Code Sec. 752(a)]. Partner C’s ultimate share of the bank debt ($10,000 per the separate agreement) plus his original basis of $30,000 gives him an adjusted basis of $40,000. Although Partner C’s share of the partnership loss is 60% of $70,000, or $42,000, his deductible loss is limited to his adjusted basis of $40,000 [Code Sec. 704(d)].

Partnership LIFE’s profits and losses are shared equally among the four partners. The adjusted basis of Partner E’s interest in the partnership on December 31, Year 1, was $25,000. On January 2, Year 2, Partner E withdrew $10,000 cash. The partnership reported $200,000 as ordinary income on its Year 2 partnership return. In addition, $5,000 for qualified travel, meals, and entertainment was shown on a separate attachment to E’s Schedule K-1 of Form 1065. Due to the limitation, $2,500 of the $5,000 is unallowable as a deduction. What is the amount of E’s basis in the partnership on December 31, Year 2?

• $60,000

  
  

• $61,000

  
  

• $65,000

  
  

• $75,000

  
  

Answer explanation

The adjusted basis of a partner’s interest is the original basis of such interest, increased by the partner’s distributive share of the partnership’s income and allocable portion of liabilities, and decreased by the partner’s distributive share of partnership loss and distributions (Secs. 705, 733, and 752). Partnership basis is also reduced by both deductible and nondeductible expenses.

Beginning basis $ 25,000 

Ordinary income ($200,000 × 25%) 50,000 

Cash distribution (10,000)

Travel, meals, entertainment expense (5,000)

Year-end basis $ 60,000 

The adjusted basis of Carol’s partnership interest is $50,000. She receives a distribution of $10,000 cash, land that has an adjusted basis of $30,000, and a FMV of $50,000. What is Carol’s adjusted basis in the land?

• $20,000

  
  

• $30,000

  
  

• $40,000

  
  

• $50,000

  
  

Answer explanation

Publication 541 states, “Unless there is a complete liquidation of a partner’s interest, the basis of property (other than money) distributed to the partner by a partnership is its adjusted basis to the partnership immediately before the distribution. However, the basis of the property to the partner cannot be more than the adjusted basis of his or her interest in the partnership reduced by any money received in the same transaction.” Therefore, Carol’s adjusted basis in the land is $30,000, the adjusted basis to the partnership immediately before the distribution.

Which of the following is true concerning the qualified business income deduction from a partnership?

• The deduction is taken by the partnership.

  
  

• Qualified trades and businesses are subject to special limitations that specified service trades and businesses are not.

  
  

• W-2 wage totals paid to employees are not reported.

  
  

• The partner claims the deduction on their individual return.

  
  

Answer explanation

The QBID is determined at the partner level, not the entity (i.e., partnership) level. However, the partnership reports the applicable amounts needed for the partner to claim the deduction on the partner’s Schedule K-1.

A partner is considered NOT at risk for which of the following amounts?

• The money and adjusted basis of any property the partner contributed to the activity.

  
  

• The partner’s share of net income retained by the partnership.

  
  

• An allocation of a loss, deduction, or expense attributable to a partnership nonrecourse liability.

  
  

• Certain amounts borrowed by the partnership for use in the activity if the partner is personally liable for repayment.

  
  

Answer explanation

Section 465 states that each partner may deduct only a partnership ordinary loss to the extent (s)he is at risk with respect to the partnership. The at-risk limits also apply at the partnership level with respect to each partnership activity. The amount of a partnership loss currently deductible (up to an amount for which the partnership bears economic risk of loss with respect to each partnership activity) is allocated to partners as a deductible distributive share. Since a nonrecourse liability means that the partnership bears no economic risk of loss, there is no at-risk loss in the transaction.

At-risk rules apply to most trade or business activities, including activities conducted through a partnership. The at-risk rules limit a partner’s deductible loss to the amounts for which that partner is considered at risk in the activity. Select the statement below that is false. A partner is considered at risk for

• The money and adjusted basis of any property (s)he contributed to the activity.

  
  

• The partner’s share of net income retained by the partnership.

  
  

• Certain amounts borrowed by the partnership for use in the activity if the partner is personally liable for repayment or the amounts borrowed are secured by the partner’s property (other than property used in the activity).

  
  

• 90% of the total expected tax for the current year.

  
  

Answer explanation

Section 465 generally limits losses from an activity for each year to the amount the taxpayer has at risk in the activity at year end. A taxpayer is generally considered at risk for money and the adjusted basis of property contributed to the activity and amounts borrowed for use in the activity. However, amounts borrowed for use in the activity are not at risk if the lender has no recourse against the borrower personally, except for certain qualified financing with respect to real property. Also, the partner’s share of net income not distributed is considered in whether or not a taxpayer is at risk. However, estimated tax payments are not considered for at-risk purposes.

Which of the following is NOT reported by a partnership on a partner’s Schedule K-1 for qualified business income deduction purposes?

• Wages earned by and paid to the partner.

  
  

• The identity of the trade or business.

  
  

• W-2 wage totals paid to employees.

  
  

• Domestic noninvestment income.

  
  

Answer explanation

The partnership must report the following on the partner’s Schedule K-1 or, in the case of multiple trades or businesses of the partnership, on a separate statement:

1. a. Each trade or business that is a specified service trade or business (SSTB). The SSTBs are subject to special limitations, not applicable to the qualified trades or businesses, and generally include a trade or business where the principal asset is the reputation or skill of one or more of its employees.

2. b. The QBI, (e.g., income, gain, deduction, and loss) from the partnership’s trade or businesses.

3. c. The W-2 wage totals paid to employees by each trade or business.