Key Takeaways
- Outside basis is adjusted annually for income, losses, distributions, and contributions.
- The ordering rule: (1) income increases, (2) decreases for distributions, (3) decreases for losses.
- Partnership liabilities increase partner basis—critical for loss deductions.
- Recourse debt: allocated by economic risk of loss. Nonrecourse: by profit-sharing ratios.
- Losses cannot reduce basis below zero; excess losses are suspended.
- Tax-exempt income increases basis; nondeductible expenses decrease basis.
Partner's Basis Calculation
Why This Matters for the Exam
Partner basis is the most tested partnership topic. It determines loss deductibility, distribution taxation, and gain on sale. Master the ordering rules and debt allocation.
Expect at least 4-5 questions on basis calculations.
Annual Basis Adjustments
Partner's outside basis changes every year:
| Increases | Decreases |
|---|---|
| Additional contributions | Distributions received |
| Share of taxable income | Share of losses |
| Share of tax-exempt income | Share of nondeductible expenses |
| Increase in share of liabilities | Decrease in share of liabilities |
The Ordering Rules (Critical!)
The adjustments occur in this specific order:
| Order | Adjustment |
|---|---|
| 1 | Increase for income items |
| 2 | Decrease for distributions |
| 3 | Decrease for losses and deductions |
Why Order Matters: Income is added first, which may allow larger tax-free distributions or more loss deductions.
Basis Floor Rule
| Rule | Description |
|---|---|
| Cannot go below zero | Basis floor is $0 |
| Excess losses | Suspended indefinitely |
| Future basis | Deduct when basis restored |
Partnership Liabilities and Basis
A partner's share of partnership debt increases their outside basis:
| Why This Matters | Effect |
|---|---|
| Loss deductions | More basis = deduct more losses |
| Distributions | More basis = tax-free distributions |
| Leverage | Partners get basis without contributing cash |
Recourse vs. Nonrecourse Debt
| Debt Type | Allocation Rule |
|---|---|
| Recourse | Partner who bears economic risk of loss |
| Nonrecourse | Profit-sharing ratios (generally) |
| Qualified nonrecourse | Special rules for real estate |
Recourse Debt Example
| Scenario | Allocation |
|---|---|
| Partnership borrows $100,000 | |
| Partner A guarantees the loan | |
| Allocation | 100% to Partner A |
Nonrecourse Debt Example
| Scenario | Allocation |
|---|---|
| Partnership borrows $100,000 (nonrecourse) | |
| Partner A: 40% profit interest | |
| Partner B: 60% profit interest | |
| Partner A share | $40,000 |
| Partner B share | $60,000 |
Basis Adjustment Example
| Transaction | Amount | Running Basis |
|---|---|---|
| Beginning basis | $50,000 | |
| + Share of income | $30,000 | $80,000 |
| + Tax-exempt interest | $5,000 | $85,000 |
| - Distribution | ($20,000) | $65,000 |
| - Share of loss | ($40,000) | $25,000 |
| Ending basis | $25,000 |
Loss Limitation Example
| Scenario | Amount |
|---|---|
| Partner basis | $20,000 |
| Share of partnership loss | $35,000 |
| Deductible loss | $20,000 |
| Suspended loss | $15,000 |
| Ending basis | $0 |
Real-World Scenario
Scenario: Partner has $50,000 basis. Partnership allocates $30,000 income and $10,000 tax-exempt interest. Partner receives $25,000 distribution.
- Step 1: Add income: $50,000 + $30,000 + $10,000 = $90,000.
- Step 2: Subtract distribution: $90,000 - $25,000 = $65,000.
- Ending basis: $65,000.
On the Exam
Expect 4-5 questions on basis, typically:
- Calculation Questions: "What is the partner's ending basis?"
- Loss Limit Questions: "How much loss can the partner deduct?"
- Debt Questions: "How is nonrecourse debt allocated?"
- Order Questions: "What is the order of basis adjustments?"
The key is to remember: Order: income → distributions → losses. Losses limited to basis. Recourse = economic risk. Nonrecourse = profit ratios.
Partner D has $50,000 basis. Partnership allocates $30,000 income and $10,000 tax-exempt interest. Partner receives $25,000 distribution. Ending basis?
Partner has $20,000 basis. Partnership allocates $35,000 loss. How much can partner deduct?
Which type of partnership debt is allocated by profit-sharing ratios?