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2009 1040x

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2009 1040x

2009 1040x Publication 541 - Main Content Table of Contents Forming a PartnershipOrganizations Classified as Partnerships Family Partnership Partnership Agreement Terminating a PartnershipIRS e-file (Electronic Filing) Exclusion From Partnership Rules Partnership Return (Form 1065) Partnership DistributionsSubstantially appreciated inventory items. 2009 1040x Partner's Gain or Loss Partner's Basis for Distributed Property Transactions Between Partnership and PartnersGuaranteed Payments Sale or Exchange of Property Contribution of Property Contribution of Services Basis of Partner's InterestAdjusted Basis Effect of Partnership Liabilities Disposition of Partner's InterestSale, Exchange, or Other Transfer Payments for Unrealized Receivables and Inventory Items Liquidation at Partner's Retirement or Death Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)Partnership Item. 2009 1040x Small Partnerships and the Small Partnership Exception Small Partnership TEFRA Election Role of Tax Matters Partner (TMP) in TEFRA Proceedings Statute of Limitations and TEFRA Amended Returns and Administrative Adjustment Requests (AARs) How To Get Tax Help Forming a Partnership The following sections contain general information about partnerships. 2009 1040x Organizations Classified as Partnerships An unincorporated organization with two or more members is generally classified as a partnership for federal tax purposes if its members carry on a trade, business, financial operation, or venture and divide its profits. 2009 1040x However, a joint undertaking merely to share expenses is not a partnership. 2009 1040x For example, co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants. 2009 1040x The rules you must use to determine whether an organization is classified as a partnership changed for organizations formed after 1996. 2009 1040x Organizations formed after 1996. 2009 1040x   An organization formed after 1996 is classified as a partnership for federal tax purposes if it has two or more members and it is none of the following. 2009 1040x An organization formed under a federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic. 2009 1040x An organization formed under a state law that refers to it as a joint-stock company or joint-stock association. 2009 1040x An insurance company. 2009 1040x Certain banks. 2009 1040x An organization wholly owned by a state, local, or foreign government. 2009 1040x An organization specifically required to be taxed as a corporation by the Internal Revenue Code (for example, certain publicly traded partnerships). 2009 1040x Certain foreign organizations identified in section 301. 2009 1040x 7701-2(b)(8) of the regulations. 2009 1040x A tax-exempt organization. 2009 1040x A real estate investment trust. 2009 1040x An organization classified as a trust under section 301. 2009 1040x 7701-4 of the regulations or otherwise subject to special treatment under the Internal Revenue Code. 2009 1040x Any other organization that elects to be classified as a corporation by filing Form 8832. 2009 1040x For more information, see the instructions for Form 8832. 2009 1040x Limited liability company. 2009 1040x   A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC. 2009 1040x Unlike a partnership, none of the members of an LLC are personally liable for its debts. 2009 1040x An LLC may be classified for federal income tax purposes as either a partnership, a corporation, or an entity disregarded as an entity separate from its owner by applying the rules in Regulations section 301. 2009 1040x 7701-3. 2009 1040x See Form 8832 and section 301. 2009 1040x 7701-3 of the regulations for more details. 2009 1040x A domestic LLC with at least two members that does not file Form 8832 is classified as a partnership for federal income tax purposes. 2009 1040x Organizations formed before 1997. 2009 1040x   An organization formed before 1997 and classified as a partnership under the old rules will generally continue to be classified as a partnership as long as the organization has at least two members and does not elect to be classified as a corporation by filing Form 8832. 2009 1040x Community property. 2009 1040x    Spouses who own a qualified entity (defined later) can choose to classify the entity as a partnership for federal tax purposes by filing the appropriate partnership tax returns. 2009 1040x They can choose to classify the entity as a sole proprietorship by filing a Schedule C (Form 1040) listing one spouse as the sole proprietor. 2009 1040x A change in reporting position will be treated for federal tax purposes as a conversion of the entity. 2009 1040x   A qualified entity is a business entity that meets all the following requirements. 2009 1040x The business entity is wholly owned by spouses as community property under the laws of a state, a foreign country, or a possession of the United States. 2009 1040x No person other than one or both spouses would be considered an owner for federal tax purposes. 2009 1040x The business entity is not treated as a corporation. 2009 1040x   For more information about community property, see Publication 555, Community Property. 2009 1040x Publication 555 discusses the community property laws of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. 2009 1040x Family Partnership Members of a family can be partners. 2009 1040x However, family members (or any other person) will be recognized as partners only if one of the following requirements is met. 2009 1040x If capital is a material income-producing factor, they acquired their capital interest in a bona fide transaction (even if by gift or purchase from another family member), actually own the partnership interest, and actually control the interest. 2009 1040x If capital is not a material income-producing factor, they joined together in good faith to conduct a business. 2009 1040x They agreed that contributions of each entitle them to a share in the profits, and some capital or service has been (or is) provided by each partner. 2009 1040x Capital is material. 2009 1040x   Capital is a material income-producing factor if a substantial part of the gross income of the business comes from the use of capital. 2009 1040x Capital is ordinarily an income-producing factor if the operation of the business requires substantial inventories or investments in plants, machinery, or equipment. 2009 1040x Capital is not material. 2009 1040x   In general, capital is not a material income-producing factor if the income of the business consists principally of fees, commissions, or other compensation for personal services performed by members or employees of the partnership. 2009 1040x Capital interest. 2009 1040x   A capital interest in a partnership is an interest in its assets that is distributable to the owner of the interest in either of the following situations. 2009 1040x The owner withdraws from the partnership. 2009 1040x The partnership liquidates. 2009 1040x   The mere right to share in earnings and profits is not a capital interest in the partnership. 2009 1040x Gift of capital interest. 2009 1040x   If a family member (or any other person) receives a gift of a capital interest in a partnership in which capital is a material income-producing factor, the donee's distributive share of partnership income is subject to both of the following restrictions. 2009 1040x It must be figured by reducing the partnership income by reasonable compensation for services the donor renders to the partnership. 2009 1040x The donee's distributive share of partnership income attributable to donated capital must not be proportionately greater than the donor's distributive share attributable to the donor's capital. 2009 1040x Purchase. 2009 1040x   For purposes of determining a partner's distributive share, an interest purchased by one family member from another family member is considered a gift from the seller. 2009 1040x The fair market value of the purchased interest is considered donated capital. 2009 1040x For this purpose, members of a family include only spouses, ancestors, and lineal descendants (or a trust for the primary benefit of those persons). 2009 1040x Example. 2009 1040x A father sold 50% of his business to his son. 2009 1040x The resulting partnership had a profit of $60,000. 2009 1040x Capital is a material income-producing factor. 2009 1040x The father performed services worth $24,000, which is reasonable compensation, and the son performed no services. 2009 1040x The $24,000 must be allocated to the father as compensation. 2009 1040x Of the remaining $36,000 of profit due to capital, at least 50%, or $18,000, must be allocated to the father since he owns a 50% capital interest. 2009 1040x The son's share of partnership profit cannot be more than $18,000. 2009 1040x Business owned and operated by spouses. 2009 1040x   If spouses carry on a business together and share in the profits and losses, they may be partners whether or not they have a formal partnership agreement. 2009 1040x If so, they should report income or loss from the business on Form 1065. 2009 1040x They should not report the income on a Schedule C (Form 1040) in the name of one spouse as a sole proprietor. 2009 1040x However, the spouses can elect not to treat the joint venture as a partnership by making a Qualified Joint Venture Election. 2009 1040x Qualified Joint Venture Election. 2009 1040x   A "qualified joint venture," whose only members are spouses filing a joint return, can elect not to be treated as a partnership for federal tax purposes. 2009 1040x A qualified joint venture conducts a trade or business where: the only members of the joint venture are spouses filing jointly; both spouses elect not to be treated as a partnership; both spouses materially participate in the trade or business (see Passive Activity Limitations in the Instructions for Form 1065 for a definition of material participation); and the business is co-owned by both spouses and is not held in the name of a state law entity such as a partnership or LLC. 2009 1040x   Under this election, a qualified joint venture conducted by spouses who file a joint return is not treated as a partnership for federal tax purposes and therefore does not have a Form 1065 filing requirement. 2009 1040x All items of income, gain, deduction, loss, and credit are divided between the spouses based on their respective interests in the venture. 2009 1040x Each spouse takes into account his or her respective share of these items as a sole proprietor. 2009 1040x Each spouse would account for his or her respective share on the appropriate form, such as Schedule C (Form 1040). 2009 1040x For purposes of determining net earnings from self-employment, each spouse's share of income or loss from a qualified joint venture is taken into account just as it is for federal income tax purposes (i. 2009 1040x e. 2009 1040x , based on their respective interests in the venture). 2009 1040x   If the spouses do not make the election to treat their respective interests in the joint venture as sole proprietorships, each spouse should carry his or her share of the partnership income or loss from Schedule K-1 (Form 1065) to their joint or separate Form(s) 1040. 2009 1040x Each spouse should include his or her respective share of self-employment income on a separate Schedule SE (Form 1040), Self-Employment Tax. 2009 1040x   This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based. 2009 1040x However, this may not be true if either spouse exceeds the social security tax limitation. 2009 1040x   For more information on qualified joint ventures, go to IRS. 2009 1040x gov, enter “Election for Qualified Joint Ventures” in the search box and select the link reading “Election for Husband and Wife Unincorporated Businesses. 2009 1040x ” Partnership Agreement The partnership agreement includes the original agreement and any modifications. 2009 1040x The modifications must be agreed to by all partners or adopted in any other manner provided by the partnership agreement. 2009 1040x The agreement or modifications can be oral or written. 2009 1040x Partners can modify the partnership agreement for a particular tax year after the close of the year but not later than the date for filing the partnership return for that year. 2009 1040x This filing date does not include any extension of time. 2009 1040x If the partnership agreement or any modification is silent on any matter, the provisions of local law are treated as part of the agreement. 2009 1040x Terminating a Partnership A partnership terminates when one of the following events takes place. 2009 1040x All its operations are discontinued and no part of any business, financial operation, or venture is continued by any of its partners in a partnership. 2009 1040x At least 50% of the total interest in partnership capital and profits is sold or exchanged within a 12-month period, including a sale or exchange to another partner. 2009 1040x Unlike other partnerships, an electing large partnership does not terminate on the sale or exchange of 50% or more of the partnership interests within a 12-month period. 2009 1040x See section 1. 2009 1040x 708-1(b) of the regulations for more information on the termination of a partnership. 2009 1040x For special rules that apply to a merger, consolidation, or division of a partnership, see sections 1. 2009 1040x 708-1(c) and 1. 2009 1040x 708-1(d) of the regulations. 2009 1040x Date of termination. 2009 1040x   The partnership's tax year ends on the date of termination. 2009 1040x For the event described in (1), above, the date of termination is the date the partnership completes the winding up of its affairs. 2009 1040x For the event described in (2), above, the date of termination is the date of the sale or exchange of a partnership interest that, by itself or together with other sales or exchanges in the preceding 12 months, transfers an interest of 50% or more in both capital and profits. 2009 1040x Short period return. 2009 1040x   If a partnership is terminated before the end of what would otherwise be its tax year, Form 1065 must be filed for the short period, which is the period from the beginning of the tax year through the date of termination. 2009 1040x The return is due the 15th day of the fourth month following the date of termination. 2009 1040x See Partnership Return (Form 1065), later, for information about filing Form 1065. 2009 1040x Conversion of partnership into limited liability company (LLC). 2009 1040x   The conversion of a partnership into an LLC classified as a partnership for federal tax purposes does not terminate the partnership. 2009 1040x The conversion is not a sale, exchange, or liquidation of any partnership interest; the partnership's tax year does not close; and the LLC can continue to use the partnership's taxpayer identification number. 2009 1040x   However, the conversion may change some of the partners' bases in their partnership interests if the partnership has recourse liabilities that become nonrecourse liabilities. 2009 1040x Because the partners share recourse and nonrecourse liabilities differently, their bases must be adjusted to reflect the new sharing ratios. 2009 1040x If a decrease in a partner's share of liabilities exceeds the partner's basis, he or she must recognize gain on the excess. 2009 1040x For more information, see Effect of Partnership Liabilities under Basis of Partner's Interest, later. 2009 1040x   The same rules apply if an LLC classified as a partnership is converted into a partnership. 2009 1040x IRS e-file (Electronic Filing) Please click here for the text description of the image. 2009 1040x e-file Certain partnerships with more than 100 partners are required to file Form 1065, Schedules K-1, and related forms and schedules electronically (e-file). 2009 1040x Other partnerships generally have the option to file electronically. 2009 1040x For details about IRS e-file, see the Form 1065 instructions. 2009 1040x Exclusion From Partnership Rules Certain partnerships that do not actively conduct a business can choose to be completely or partially excluded from being treated as partnerships for federal income tax purposes. 2009 1040x All the partners must agree to make the choice, and the partners must be able to compute their own taxable income without computing the partnership's income. 2009 1040x However, the partners are not exempt from the rule that limits a partner's distributive share of partnership loss to the adjusted basis of the partner's partnership interest. 2009 1040x Nor are they exempt from the requirement of a business purpose for adopting a tax year for the partnership that differs from its required tax year. 2009 1040x Investing partnership. 2009 1040x   An investing partnership can be excluded if the participants in the joint purchase, retention, sale, or exchange of investment property meet all the following requirements. 2009 1040x They own the property as co-owners. 2009 1040x They reserve the right separately to take or dispose of their shares of any property acquired or retained. 2009 1040x They do not actively conduct business or irrevocably authorize some person acting in a representative capacity to purchase, sell, or exchange the investment property. 2009 1040x Each separate participant can delegate authority to purchase, sell, or exchange his or her share of the investment property for the time being for his or her account, but not for a period of more than a year. 2009 1040x Operating agreement partnership. 2009 1040x   An operating agreement partnership group can be excluded if the participants in the joint production, extraction, or use of property meet all the following requirements. 2009 1040x They own the property as co-owners, either in fee or under lease or other form of contract granting exclusive operating rights. 2009 1040x They reserve the right separately to take in kind or dispose of their shares of any property produced, extracted, or used. 2009 1040x They do not jointly sell services or the property produced or extracted. 2009 1040x Each separate participant can delegate authority to sell his or her share of the property produced or extracted for the time being for his or her account, but not for a period of time in excess of the minimum needs of the industry, and in no event for more than one year. 2009 1040x However, this exclusion does not apply to an unincorporated organization one of whose principal purposes is cycling, manufacturing, or processing for persons who are not members of the organization. 2009 1040x Electing the exclusion. 2009 1040x   An eligible organization that wishes to be excluded from the partnership rules must make the election not later than the time for filing the partnership return for the first tax year for which exclusion is desired. 2009 1040x This filing date includes any extension of time. 2009 1040x See Regulations section 1. 2009 1040x 761-2(b) for the procedures to follow. 2009 1040x Partnership Return (Form 1065) Every partnership that engages in a trade or business or has gross income must file an information return on Form 1065 showing its income, deductions, and other required information. 2009 1040x The partnership return must show the names and addresses of each partner and each partner's distributive share of taxable income. 2009 1040x The return must be signed by a general partner. 2009 1040x If a limited liability company is treated as a partnership, it must file Form 1065 and one of its members must sign the return. 2009 1040x A partnership is not considered to engage in a trade or business, and is not required to file a Form 1065, for any tax year in which it neither receives income nor pays or incurs any expenses treated as deductions or credits for federal income tax purposes. 2009 1040x See the Instructions for Form 1065 for more information about who must file Form 1065. 2009 1040x Partnership Distributions Partnership distributions include the following. 2009 1040x A withdrawal by a partner in anticipation of the current year's earnings. 2009 1040x A distribution of the current year's or prior years' earnings not needed for working capital. 2009 1040x A complete or partial liquidation of a partner's interest. 2009 1040x A distribution to all partners in a complete liquidation of the partnership. 2009 1040x A partnership distribution is not taken into account in determining the partner's distributive share of partnership income or loss. 2009 1040x If any gain or loss from the distribution is recognized by the partner, it must be reported on his or her return for the tax year in which the distribution is received. 2009 1040x Money or property withdrawn by a partner in anticipation of the current year's earnings is treated as a distribution received on the last day of the partnership's tax year. 2009 1040x Effect on partner's basis. 2009 1040x   A partner's adjusted basis in his or her partnership interest is decreased (but not below zero) by the money and adjusted basis of property distributed to the partner. 2009 1040x See Adjusted Basis under Basis of Partner's Interest, later. 2009 1040x Effect on partnership. 2009 1040x   A partnership generally does not recognize any gain or loss because of distributions it makes to partners. 2009 1040x The partnership may be able to elect to adjust the basis of its undistributed property. 2009 1040x Certain distributions treated as a sale or exchange. 2009 1040x   When a partnership distributes the following items, the distribution may be treated as a sale or exchange of property rather than a distribution. 2009 1040x Unrealized receivables or substantially appreciated inventory items distributed in exchange for any part of the partner's interest in other partnership property, including money. 2009 1040x Other property (including money) distributed in exchange for any part of a partner's interest in unrealized receivables or substantially appreciated inventory items. 2009 1040x   See Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. 2009 1040x   This treatment does not apply to the following distributions. 2009 1040x A distribution of property to the partner who contributed the property to the partnership. 2009 1040x Payments made to a retiring partner or successor in interest of a deceased partner that are the partner's distributive share of partnership income or guaranteed payments. 2009 1040x Substantially appreciated inventory items. 2009 1040x   Inventory items of the partnership are considered to have appreciated substantially in value if, at the time of the distribution, their total fair market value is more than 120% of the partnership's adjusted basis for the property. 2009 1040x However, if a principal purpose for acquiring inventory property is to avoid ordinary income treatment by reducing the appreciation to less than 120%, that property is excluded. 2009 1040x Partner's Gain or Loss A partner generally recognizes gain on a partnership distribution only to the extent any money (and marketable securities treated as money) included in the distribution exceeds the adjusted basis of the partner's interest in the partnership. 2009 1040x Any gain recognized is generally treated as capital gain from the sale of the partnership interest on the date of the distribution. 2009 1040x If partnership property (other than marketable securities treated as money) is distributed to a partner, he or she generally does not recognize any gain until the sale or other disposition of the property. 2009 1040x For exceptions to these rules, see Distribution of partner's debt and Net precontribution gain, later. 2009 1040x Also, see Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. 2009 1040x Example. 2009 1040x The adjusted basis of Jo's partnership interest is $14,000. 2009 1040x She receives a distribution of $8,000 cash and land that has an adjusted basis of $2,000 and a fair market value of $3,000. 2009 1040x Because the cash received does not exceed the basis of her partnership interest, Jo does not recognize any gain on the distribution. 2009 1040x Any gain on the land will be recognized when she sells or otherwise disposes of it. 2009 1040x The distribution decreases the adjusted basis of Jo's partnership interest to $4,000 [$14,000 − ($8,000 + $2,000)]. 2009 1040x Marketable securities treated as money. 2009 1040x   Generally, a marketable security distributed to a partner is treated as money in determining whether gain is recognized on the distribution. 2009 1040x This treatment, however, does not generally apply if that partner contributed the security to the partnership or an investment partnership made the distribution to an eligible partner. 2009 1040x   The amount treated as money is the security's fair market value when distributed, reduced (but not below zero) by the excess (if any) of: The partner's distributive share of the gain that would be recognized had the partnership sold all its marketable securities at their fair market value immediately before the transaction resulting in the distribution, over The partner's distributive share of the gain that would be recognized had the partnership sold all such securities it still held after the distribution at the fair market value in (1). 2009 1040x   For more information, including the definition of marketable securities, see section 731(c) of the Internal Revenue Code. 2009 1040x Loss on distribution. 2009 1040x   A partner does not recognize loss on a partnership distribution unless all the following requirements are met. 2009 1040x The adjusted basis of the partner's interest in the partnership exceeds the distribution. 2009 1040x The partner's entire interest in the partnership is liquidated. 2009 1040x The distribution is in money, unrealized receivables, or inventory items. 2009 1040x   There are exceptions to these general rules. 2009 1040x See the following discussions. 2009 1040x Also, see Liquidation at Partner's Retirement or Death under Disposition of Partner's Interest, later. 2009 1040x Distribution of partner's debt. 2009 1040x   If a partnership acquires a partner's debt and extinguishes the debt by distributing it to the partner, the partner will recognize capital gain or loss to the extent the fair market value of the debt differs from the basis of the debt (determined under the rules discussed in Partner's Basis for Distributed Property, later). 2009 1040x   The partner is treated as having satisfied the debt for its fair market value. 2009 1040x If the issue price (adjusted for any premium or discount) of the debt exceeds its fair market value when distributed, the partner may have to include the excess amount in income as canceled debt. 2009 1040x   Similarly, a deduction may be available to a corporate partner if the fair market value of the debt at the time of distribution exceeds its adjusted issue price. 2009 1040x Net precontribution gain. 2009 1040x   A partner generally must recognize gain on the distribution of property (other than money) if the partner contributed appreciated property to the partnership during the 7-year period before the distribution. 2009 1040x   The gain recognized is the lesser of the following amounts. 2009 1040x The excess of: The fair market value of the property received in the distribution, over The adjusted basis of the partner's interest in the partnership immediately before the distribution, reduced (but not below zero) by any money received in the distribution. 2009 1040x The “net precontribution gain” of the partner. 2009 1040x This is the net gain the partner would recognize if all the property contributed by the partner within 7 years of the distribution, and held by the partnership immediately before the distribution, were distributed to another partner, other than a partner who owns more than 50% of the partnership. 2009 1040x For information about the distribution of contributed property to another partner, see Contribution of Property , under Transactions Between Partnership and Partners, later. 2009 1040x   The character of the gain is determined by reference to the character of the net precontribution gain. 2009 1040x This gain is in addition to any gain the partner must recognize if the money distributed is more than his or her basis in the partnership. 2009 1040x For these rules, the term “money” includes marketable securities treated as money, as discussed earlier. 2009 1040x Effect on basis. 2009 1040x   The adjusted basis of the partner's interest in the partnership is increased by any net precontribution gain recognized by the partner. 2009 1040x Other than for purposes of determining the gain, the increase is treated as occurring immediately before the distribution. 2009 1040x See Basis of Partner's Interest , later. 2009 1040x   The partnership must adjust its basis in any property the partner contributed within 7 years of the distribution to reflect any gain that partner recognizes under this rule. 2009 1040x Exceptions. 2009 1040x   Any part of a distribution that is property the partner previously contributed to the partnership is not taken into account in determining the amount of the excess distribution or the partner's net precontribution gain. 2009 1040x For this purpose, the partner's previously contributed property does not include a contributed interest in an entity to the extent its value is due to property contributed to the entity after the interest was contributed to the partnership. 2009 1040x   Recognition of gain under this rule also does not apply to a distribution of unrealized receivables or substantially appreciated inventory items if the distribution is treated as a sale or exchange, as discussed earlier. 2009 1040x Partner's Basis for Distributed Property 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. 2009 1040x 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. 2009 1040x Example 1. 2009 1040x The adjusted basis of Emily's partnership interest is $30,000. 2009 1040x She receives a distribution of property that has an adjusted basis of $20,000 to the partnership and $4,000 in cash. 2009 1040x Her basis for the property is $20,000. 2009 1040x Example 2. 2009 1040x The adjusted basis of Steve's partnership interest is $10,000. 2009 1040x He receives a distribution of $4,000 cash and property that has an adjusted basis to the partnership of $8,000. 2009 1040x His basis for the distributed property is limited to $6,000 ($10,000 − $4,000, the cash he receives). 2009 1040x Complete liquidation of partner's interest. 2009 1040x   The basis of property received in complete liquidation of a partner's interest is the adjusted basis of the partner's interest in the partnership reduced by any money distributed to the partner in the same transaction. 2009 1040x Partner's holding period. 2009 1040x   A partner's holding period for property distributed to the partner includes the period the property was held by the partnership. 2009 1040x If the property was contributed to the partnership by a partner, then the period it was held by that partner is also included. 2009 1040x Basis divided among properties. 2009 1040x   If the basis of property received is the adjusted basis of the partner's interest in the partnership (reduced by money received in the same transaction), it must be divided among the properties distributed to the partner. 2009 1040x For property distributed after August 5, 1997, allocate the basis using the following rules. 2009 1040x Allocate the basis first to unrealized receivables and inventory items included in the distribution by assigning a basis to each item equal to the partnership's adjusted basis in the item immediately before the distribution. 2009 1040x If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. 2009 1040x Allocate any remaining basis to properties other than unrealized receivables and inventory items by assigning a basis to each property equal to the partnership's adjusted basis in the property immediately before the distribution. 2009 1040x If the allocable basis exceeds the total of these assigned bases, increase the assigned bases by the amount of the excess. 2009 1040x If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. 2009 1040x Allocating a basis increase. 2009 1040x   Allocate any basis increase required in rule (2), above, first to properties with unrealized appreciation to the extent of the unrealized appreciation. 2009 1040x If the basis increase is less than the total unrealized appreciation, allocate it among those properties in proportion to their respective amounts of unrealized appreciation. 2009 1040x Allocate any remaining basis increase among all the properties in proportion to their respective fair market values. 2009 1040x Example. 2009 1040x Eun's basis in her partnership interest is $55,000. 2009 1040x In a distribution in liquidation of her entire interest, she receives properties A and B, neither of which is inventory or unrealized receivables. 2009 1040x Property A has an adjusted basis to the partnership of $5,000 and a fair market value of $40,000. 2009 1040x Property B has an adjusted basis to the partnership of $10,000 and a fair market value of $10,000. 2009 1040x To figure her basis in each property, Eun first assigns bases of $5,000 to property A and $10,000 to property B (their adjusted bases to the partnership). 2009 1040x This leaves a $40,000 basis increase (the $55,000 allocable basis minus the $15,000 total of the assigned bases). 2009 1040x She first allocates $35,000 to property A (its unrealized appreciation). 2009 1040x The remaining $5,000 is allocated between the properties based on their fair market values. 2009 1040x $4,000 ($40,000/$50,000) is allocated to property A and $1,000 ($10,000/$50,000) is allocated to property B. 2009 1040x Eun's basis in property A is $44,000 ($5,000 + $35,000 + $4,000) and her basis in property B is $11,000 ($10,000 + $1,000). 2009 1040x Allocating a basis decrease. 2009 1040x   Use the following rules to allocate any basis decrease required in rule (1) or rule (2), earlier. 2009 1040x Allocate the basis decrease first to items with unrealized depreciation to the extent of the unrealized depreciation. 2009 1040x If the basis decrease is less than the total unrealized depreciation, allocate it among those items in proportion to their respective amounts of unrealized depreciation. 2009 1040x Allocate any remaining basis decrease among all the items in proportion to their respective assigned basis amounts (as decreased in (1)). 2009 1040x Example. 2009 1040x Armando's basis in his partnership interest is $20,000. 2009 1040x In a distribution in liquidation of his entire interest, he receives properties C and D, neither of which is inventory or unrealized receivables. 2009 1040x Property C has an adjusted basis to the partnership of $15,000 and a fair market value of $15,000. 2009 1040x Property D has an adjusted basis to the partnership of $15,000 and a fair market value of $5,000. 2009 1040x To figure his basis in each property, Armando first assigns bases of $15,000 to property C and $15,000 to property D (their adjusted bases to the partnership). 2009 1040x This leaves a $10,000 basis decrease (the $30,000 total of the assigned bases minus the $20,000 allocable basis). 2009 1040x He allocates the entire $10,000 to property D (its unrealized depreciation). 2009 1040x Armando's basis in property C is $15,000 and his basis in property D is $5,000 ($15,000 − $10,000). 2009 1040x Distributions before August 6, 1997. 2009 1040x   For property distributed before August 6, 1997, allocate the basis using the following rules. 2009 1040x Allocate the basis first to unrealized receivables and inventory items included in the distribution to the extent of the partnership's adjusted basis in those items. 2009 1040x If the partnership's adjusted basis in those items exceeded the allocable basis, allocate the basis among the items in proportion to their adjusted bases to the partnership. 2009 1040x Allocate any remaining basis to other distributed properties in proportion to their adjusted bases to the partnership. 2009 1040x Partner's interest more than partnership basis. 2009 1040x   If the basis of a partner's interest to be divided in a complete liquidation of the partner's interest is more than the partnership's adjusted basis for the unrealized receivables and inventory items distributed, and if no other property is distributed to which the partner can apply the remaining basis, the partner has a capital loss to the extent of the remaining basis of the partnership interest. 2009 1040x Special adjustment to basis. 2009 1040x   A partner who acquired any part of his or her partnership interest in a sale or exchange or upon the death of another partner may be able to choose a special basis adjustment for property distributed by the partnership. 2009 1040x To choose the special adjustment, the partner must have received the distribution within 2 years after acquiring the partnership interest. 2009 1040x Also, the partnership must not have chosen the optional adjustment to basis when the partner acquired the partnership interest. 2009 1040x   If a partner chooses this special basis adjustment, the partner's basis for the property distributed is the same as it would have been if the partnership had chosen the optional adjustment to basis. 2009 1040x However, this assigned basis is not reduced by any depletion or depreciation that would have been allowed or allowable if the partnership had previously chosen the optional adjustment. 2009 1040x   The choice must be made with the partner's tax return for the year of the distribution if the distribution includes any property subject to depreciation, depletion, or amortization. 2009 1040x If the choice does not have to be made for the distribution year, it must be made with the return for the first year in which the basis of the distributed property is pertinent in determining the partner's income tax. 2009 1040x   A partner choosing this special basis adjustment must attach a statement to his or her tax return that the partner chooses under section 732(d) of the Internal Revenue Code to adjust the basis of property received in a distribution. 2009 1040x The statement must show the computation of the special basis adjustment for the property distributed and list the properties to which the adjustment has been allocated. 2009 1040x Example. 2009 1040x Chin Ho purchased a 25% interest in X partnership for $17,000 cash. 2009 1040x At the time of the purchase, the partnership owned inventory having a basis to the partnership of $14,000 and a fair market value of $16,000. 2009 1040x Thus, $4,000 of the $17,000 he paid was attributable to his share of inventory with a basis to the partnership of $3,500. 2009 1040x Within 2 years after acquiring his interest, Chin Ho withdrew from the partnership and for his entire interest received cash of $1,500, inventory with a basis to the partnership of $3,500, and other property with a basis of $6,000. 2009 1040x The value of the inventory received was 25% of the value of all partnership inventory. 2009 1040x (It is immaterial whether the inventory he received was on hand when he acquired his interest. 2009 1040x ) Since the partnership from which Chin Ho withdrew did not make the optional adjustment to basis, he chose to adjust the basis of the inventory received. 2009 1040x His share of the partnership's basis for the inventory is increased by $500 (25% of the $2,000 difference between the $16,000 fair market value of the inventory and its $14,000 basis to the partnership at the time he acquired his interest). 2009 1040x The adjustment applies only for purposes of determining his new basis in the inventory, and not for purposes of partnership gain or loss on disposition. 2009 1040x The total to be allocated among the properties Chin Ho received in the distribution is $15,500 ($17,000 basis of his interest − $1,500 cash received). 2009 1040x His basis in the inventory items is $4,000 ($3,500 partnership basis + $500 special adjustment). 2009 1040x The remaining $11,500 is allocated to his new basis for the other property he received. 2009 1040x Mandatory adjustment. 2009 1040x   A partner does not always have a choice of making this special adjustment to basis. 2009 1040x The special adjustment to basis must be made for a distribution of property (whether or not within 2 years after the partnership interest was acquired) if all the following conditions existed when the partner received the partnership interest. 2009 1040x The fair market value of all partnership property (other than money) was more than 110% of its adjusted basis to the partnership. 2009 1040x If there had been a liquidation of the partner's interest immediately after it was acquired, an allocation of the basis of that interest under the general rules (discussed earlier under Basis divided among properties) would have decreased the basis of property that could not be depreciated, depleted, or amortized and increased the basis of property that could be. 2009 1040x The optional basis adjustment, if it had been chosen by the partnership, would have changed the partner's basis for the property actually distributed. 2009 1040x Required statement. 2009 1040x   Generally, if a partner chooses a special basis adjustment and notifies the partnership, or if the partnership makes a distribution for which the special basis adjustment is mandatory, the partnership must provide a statement to the partner. 2009 1040x The statement must provide information necessary for the partner to compute the special basis adjustment. 2009 1040x Marketable securities. 2009 1040x   A partner's basis in marketable securities received in a partnership distribution, as determined in the preceding discussions, is increased by any gain recognized by treating the securities as money. 2009 1040x See Marketable securities treated as money under Partner's Gain or Loss, earlier. 2009 1040x The basis increase is allocated among the securities in proportion to their respective amounts of unrealized appreciation before the basis increase. 2009 1040x Transactions Between Partnership and Partners For certain transactions between a partner and his or her partnership, the partner is treated as not being a member of the partnership. 2009 1040x These transactions include the following. 2009 1040x Performing services for, or transferring property to, a partnership if: There is a related allocation and distribution to a partner, and The entire transaction, when viewed together, is properly characterized as occurring between the partnership and a partner not acting in the capacity of a partner. 2009 1040x Transferring money or other property to a partnership if: There is a related transfer of money or other property by the partnership to the contributing partner or another partner, and The transfers together are properly characterized as a sale or exchange of property. 2009 1040x Payments by accrual basis partnership to cash basis partner. 2009 1040x   A partnership that uses an accrual method of accounting cannot deduct any business expense owed to a cash basis partner until the amount is paid. 2009 1040x However, this rule does not apply to guaranteed payments made to a partner, which are generally deductible when accrued. 2009 1040x Guaranteed Payments Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. 2009 1040x A partnership treats guaranteed payments for services, or for the use of capital, as if they were made to a person who is not a partner. 2009 1040x This treatment is for purposes of determining gross income and deductible business expenses only. 2009 1040x For other tax purposes, guaranteed payments are treated as a partner's distributive share of ordinary income. 2009 1040x Guaranteed payments are not subject to income tax withholding. 2009 1040x The partnership generally deducts guaranteed payments on line 10 of Form 1065 as a business expense. 2009 1040x They are also listed on Schedules K and K-1 of the partnership return. 2009 1040x The individual partner reports guaranteed payments on Schedule E (Form 1040) as ordinary income, along with his or her distributive share of the partnership's other ordinary income. 2009 1040x Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenses. 2009 1040x Generally, organizational and syndication expenses are not deductible by the partnership. 2009 1040x However, a partnership can elect to deduct a portion of its organizational expenses and amortize the remaining expenses (see Business start-up and organizational costs in the Instructions for Form 1065). 2009 1040x Organizational expenses (if the election is not made) and syndication expenses paid to partners must be reported on the partners' Schedule K-1 as guaranteed payments. 2009 1040x Minimum payment. 2009 1040x   If a partner is to receive a minimum payment from the partnership, the guaranteed payment is the amount by which the minimum payment is more than the partner's distributive share of the partnership income before taking into account the guaranteed payment. 2009 1040x Example. 2009 1040x Under a partnership agreement, Divya is to receive 30% of the partnership income, but not less than $8,000. 2009 1040x The partnership has net income of $20,000. 2009 1040x Divya's share, without regard to the minimum guarantee, is $6,000 (30% × $20,000). 2009 1040x The guaranteed payment that can be deducted by the partnership is $2,000 ($8,000 − $6,000). 2009 1040x Divya's income from the partnership is $8,000, and the remaining $12,000 of partnership income will be reported by the other partners in proportion to their shares under the partnership agreement. 2009 1040x If the partnership net income had been $30,000, there would have been no guaranteed payment since her share, without regard to the guarantee, would have been greater than the guarantee. 2009 1040x Self-employed health insurance premiums. 2009 1040x   Premiums for health insurance paid by a partnership on behalf of a partner, for services as a partner, are treated as guaranteed payments. 2009 1040x The partnership can deduct the payments as a business expense, and the partner must include them in gross income. 2009 1040x However, if the partnership accounts for insurance paid for a partner as a reduction in distributions to the partner, the partnership cannot deduct the premiums. 2009 1040x   A partner who qualifies can deduct 100% of the health insurance premiums paid by the partnership on his or her behalf as an adjustment to income. 2009 1040x The partner cannot deduct the premiums for any calendar month, or part of a month, in which the partner is eligible to participate in any subsidized health plan maintained by any employer of the partner, the partner's spouse, the partner's dependents, or any children under age 27 who are not dependents. 2009 1040x For more information on the self-employed health insurance deduction, see chapter 6 in Publication 535. 2009 1040x Including payments in partner's income. 2009 1040x   Guaranteed payments are included in income in the partner's tax year in which the partnership's tax year ends. 2009 1040x Example 1. 2009 1040x Under the terms of a partnership agreement, Erica is entitled to a fixed annual payment of $10,000 without regard to the income of the partnership. 2009 1040x Her distributive share of the partnership income is 10%. 2009 1040x The partnership has $50,000 of ordinary income after deducting the guaranteed payment. 2009 1040x She must include ordinary income of $15,000 ($10,000 guaranteed payment + $5,000 ($50,000 × 10%) distributive share) on her individual income tax return for her tax year in which the partnership's tax year ends. 2009 1040x Example 2. 2009 1040x Lamont is a calendar year taxpayer who is a partner in a partnership. 2009 1040x The partnership uses a fiscal year that ended January 31, 2013. 2009 1040x Lamont received guaranteed payments from the partnership from February 1, 2012, until December 31, 2012. 2009 1040x He must include these guaranteed payments in income for 2013 and report them on his 2013 income tax return. 2009 1040x Payments resulting in loss. 2009 1040x   If guaranteed payments to a partner result in a partnership loss in which the partner shares, the partner must report the full amount of the guaranteed payments as ordinary income. 2009 1040x The partner separately takes into account his or her distributive share of the partnership loss, to the extent of the adjusted basis of the partner's partnership interest. 2009 1040x Sale or Exchange of Property Special rules apply to a sale or exchange of property between a partnership and certain persons. 2009 1040x Losses. 2009 1040x   Losses will not be allowed from a sale or exchange of property (other than an interest in the partnership) directly or indirectly between a partnership and a person whose direct or indirect interest in the capital or profits of the partnership is more than 50%. 2009 1040x   If the sale or exchange is between two partnerships in which the same persons directly or indirectly own more than 50% of the capital or profits interests in each partnership, no deduction of a loss is allowed. 2009 1040x   The basis of each partner's interest in the partnership is decreased (but not below zero) by the partner's share of the disallowed loss. 2009 1040x   If the purchaser later sells the property, only the gain realized that is greater than the loss not allowed will be taxable. 2009 1040x If any gain from the sale of the property is not recognized because of this rule, the basis of each partner's interest in the partnership is increased by the partner's share of that gain. 2009 1040x Gains. 2009 1040x   Gains are treated as ordinary income in a sale or exchange of property directly or indirectly between a person and a partnership, or between two partnerships, if both of the following tests are met. 2009 1040x More than 50% of the capital or profits interest in the partnership(s) is directly or indirectly owned by the same person(s). 2009 1040x The property in the hands of the transferee immediately after the transfer is not a capital asset. 2009 1040x Property that is not a capital asset includes accounts receivable, inventory, stock-in-trade, and depreciable or real property used in a trade or business. 2009 1040x More than 50% ownership. 2009 1040x   To determine if there is more than 50% ownership in partnership capital or profits, the following rules apply. 2009 1040x An interest directly or indirectly owned by, or for, a corporation, partnership, estate, or trust is considered to be owned proportionately by, or for, its shareholders, partners, or beneficiaries. 2009 1040x An individual is considered to own the interest directly or indirectly owned by, or for, the individual's family. 2009 1040x For this rule, “family” includes only brothers, sisters, half-brothers, half-sisters, spouses, ancestors, and lineal descendants. 2009 1040x If a person is considered to own an interest using rule (1), that person (the “constructive owner”) is treated as if actually owning that interest when rules (1) and (2) are applied. 2009 1040x However, if a person is considered to own an interest using rule (2), that person is not treated as actually owning that interest in reapplying rule (2) to make another person the constructive owner. 2009 1040x Example. 2009 1040x Individuals A and B and Trust T are equal partners in Partnership ABT. 2009 1040x A's husband, AH, is the sole beneficiary of Trust T. 2009 1040x Trust T's partnership interest will be attributed to AH only for the purpose of further attributing the interest to A. 2009 1040x As a result, A is a more-than-50% partner. 2009 1040x This means that any deduction for losses on transactions between her and ABT will not be allowed, and gain from property that in the hands of the transferee is not a capital asset is treated as ordinary, rather than capital, gain. 2009 1040x More information. 2009 1040x   For more information on these special rules, see Sales and Exchanges Between Related Persons in chapter 2 of Publication 544. 2009 1040x Contribution of Property Usually, neither the partner nor the partnership recognizes a gain or loss when property is contributed to the partnership in exchange for a partnership interest. 2009 1040x This applies whether a partnership is being formed or is already operating. 2009 1040x The partnership's holding period for the property includes the partner's holding period. 2009 1040x The contribution of limited partnership interests in one partnership for limited partnership interests in another partnership qualifies as a tax-free contribution of property to the second partnership if the transaction is made for business purposes. 2009 1040x The exchange is not subject to the rules explained later under Disposition of Partner's Interest. 2009 1040x Disguised sales. 2009 1040x   A contribution of money or other property to the partnership followed by a distribution of different property from the partnership to the partner is treated not as a contribution and distribution, but as a sale of property, if both of the following tests are met. 2009 1040x The distribution would not have been made but for the contribution. 2009 1040x The partner's right to the distribution does not depend on the success of partnership operations. 2009 1040x   All facts and circumstances are considered in determining if the contribution and distribution are more properly characterized as a sale. 2009 1040x However, if the contribution and distribution occur within 2 years of each other, the transfers are presumed to be a sale unless the facts clearly indicate that the transfers are not a sale. 2009 1040x If the contribution and distribution occur more than 2 years apart, the transfers are presumed not to be a sale unless the facts clearly indicate that the transfers are a sale. 2009 1040x Form 8275 required. 2009 1040x   A partner must attach Form 8275, Disclosure Statement, (or other statement) to his or her return if the partner contributes property to a partnership and, within 2 years (before or after the contribution), the partnership transfers money or other consideration to the partner. 2009 1040x For exceptions to this requirement, see section 1. 2009 1040x 707-3(c)(2) of the regulations. 2009 1040x   A partnership must attach Form 8275 (or other statement) to its return if it distributes property to a partner, and, within 2 years (before or after the distribution), the partner transfers money or other consideration to the partnership. 2009 1040x   Form 8275 must include the following information. 2009 1040x A caption identifying the statement as a disclosure under section 707 of the Internal Revenue Code. 2009 1040x A description of the transferred property or money, including its value. 2009 1040x A description of any relevant facts in determining if the transfers are properly viewed as a disguised sale. 2009 1040x See section 1. 2009 1040x 707-3(b)(2) of the regulations for a description of the facts and circumstances considered in determining if the transfers are a disguised sale. 2009 1040x Contribution to partnership treated as investment company. 2009 1040x   Gain is recognized when property is contributed (in exchange for an interest in the partnership) to a partnership that would be treated as an investment company if it were incorporated. 2009 1040x   A partnership is generally treated as an investment company if over 80% of the value of its assets is held for investment and consists of certain readily marketable items. 2009 1040x These items include money, stocks and other equity interests in a corporation, and interests in regulated investment companies and real estate investment trusts. 2009 1040x For more information, see section 351(e)(1) of the Internal Revenue Code and the related regulations. 2009 1040x Whether a partnership is treated as an investment company under this test is ordinarily determined immediately after the transfer of property. 2009 1040x   This rule applies to limited partnerships and general partnerships, regardless of whether they are privately formed or publicly syndicated. 2009 1040x Contribution to foreign partnership. 2009 1040x   A domestic partnership that contributed property after August 5, 1997, to a foreign partnership in exchange for a partnership interest may have to file Form 8865 if either of the following apply. 2009 1040x Immediately after the contribution, the partnership owned, directly or indirectly, at least a 10% interest in the foreign partnership. 2009 1040x The fair market value of the property contributed to the foreign partnership, when added to other contributions of property made to the partnership during the preceding 12-month period, is greater than $100,000. 2009 1040x   The partnership may also have to file Form 8865, even if no contributions are made during the tax year, if it owns a 10% or more interest in a foreign partnership at any time during the year. 2009 1040x See the form instructions for more information. 2009 1040x Basis of contributed property. 2009 1040x   If a partner contributes property to a partnership, the partnership's basis for determining depreciation, depletion, gain, or loss for the property is the same as the partner's adjusted basis for the property when it was contributed, increased by any gain recognized by the partner at the time of contribution. 2009 1040x Allocations to account for built-in gain or loss. 2009 1040x   The fair market value of property at the time it is contributed may be different from the partner's adjusted basis. 2009 1040x The partnership must allocate among the partners any income, deduction, gain, or loss on the property in a manner that will account for the difference. 2009 1040x This rule also applies to contributions of accounts payable and other accrued but unpaid items of a cash basis partner. 2009 1040x   The partnership can use different allocation methods for different items of contributed property. 2009 1040x A single reasonable method must be consistently applied to each item, and the overall method or combination of methods must be reasonable. 2009 1040x See section 1. 2009 1040x 704-3 of the regulations for allocation methods generally considered reasonable. 2009 1040x   If the partnership sells contributed property and recognizes gain or loss, built-in gain or loss is allocated to the contributing partner. 2009 1040x If contributed property is subject to depreciation or other cost recovery, the allocation of deductions for these items takes into account built-in gain or loss on the property. 2009 1040x However, the total depreciation, depletion, gain, or loss allocated to partners cannot be more than the depreciation or depletion allowable to the partnership or the gain or loss realized by the partnership. 2009 1040x Example. 2009 1040x Areta and Sofia formed an equal partnership. 2009 1040x Areta contributed $10,000 in cash to the partnership and Sofia contributed depreciable property with a fair market value of $10,000 and an adjusted basis of $4,000. 2009 1040x The partnership's basis for depreciation is limited to the adjusted basis of the property in Sofia's hands, $4,000. 2009 1040x In effect, Areta purchased an undivided one-half interest in the depreciable property with her contribution of $10,000. 2009 1040x Assuming that the depreciation rate is 10% a year under the General Depreciation System (GDS), she would have been entitled to a depreciation deduction of $500 per year, based on her interest in the partnership, if the adjusted basis of the property equaled its fair market value when contributed. 2009 1040x To simplify this example, the depreciation deductions are determined without regard to any first-year depreciation conventions. 2009 1040x However, since the partnership is allowed only $400 per year of depreciation (10% of $4,000), no more than $400 can be allocated between the partners. 2009 1040x The entire $400 must be allocated to Areta. 2009 1040x Distribution of contributed property to another partner. 2009 1040x   If a partner contributes property to a partnership and the partnership distributes the property to another partner within 7 years of the contribution, the contributing partner must recognize gain or loss on the distribution. 2009 1040x   The recognized gain or loss is the amount the contributing partner would have recognized if the property had been sold for its fair market value when it was distributed. 2009 1040x This amount is the difference between the property's basis and its fair market value at the time of contribution. 2009 1040x The character of the gain or loss will be the same as the character of the gain or loss that would have resulted if the partnership had sold the property to the distributee partner. 2009 1040x Appropriate adjustments must be made to the adjusted basis of the contributing partner's partnership interest and to the adjusted basis of the property distributed to reflect the recognized gain or loss. 2009 1040x Disposition of certain contributed property. 2009 1040x   The following rules determine the character of the partnership's gain or loss on a disposition of certain types of contributed property. 2009 1040x Unrealized receivables. 2009 1040x If the property was an unrealized receivable in the hands of the contributing partner, any gain or loss on its disposition by the partnership is ordinary income or loss. 2009 1040x Unrealized receivables are defined later under Payments for Unrealized Receivables and Inventory Items. 2009 1040x When reading the definition, substitute “partner” for “partnership. 2009 1040x ” Inventory items. 2009 1040x If the property was an inventory item in the hands of the contributing partner, any gain or loss on its disposition by the partnership within 5 years after the contribution is ordinary income or loss. 2009 1040x Inventory items are defined later in Payments for Unrealized Receivables and Inventory Items. 2009 1040x Capital loss property. 2009 1040x If the property was a capital asset in the contributing partner's hands, any loss on its disposition by the partnership within 5 years after the contribution is a capital loss. 2009 1040x The capital loss is limited to the amount by which the partner's adjusted basis for the property exceeded the property's fair market value immediately before the contribution. 2009 1040x Substituted basis property. 2009 1040x If the disposition of any of the property listed in (1), (2), or (3) is a nonrecognition transaction, these rules apply when the recipient of the property disposes of any substituted basis property (other than certain corporate stock) resulting from the transaction. 2009 1040x Contribution of Services A partner can acquire an interest in partnership capital or profits as compensation for services performed or to be performed. 2009 1040x Capital interest. 2009 1040x   A capital interest is an interest that would give the holder a share of the proceeds if the partnership's assets were sold at fair market value and the proceeds were distributed in a complete liquidation of the partnership. 2009 1040x This determination generally is made at the time of receipt of the partnership interest. 2009 1040x The fair market value of such an interest received by a partner as compensation for services must generally be included in the partner's gross income in the first tax year in which the partner can transfer the interest or the interest is not subject to a substantial risk of forfeiture. 2009 1040x The capital interest transferred as compensation for services is subject to the rules for restricted property discussed in Publication 525 under Employee Compensation. 2009 1040x   The fair market value of an interest in partnership capital transferred to a partner as payment for services to the partnership is a guaranteed payment, discussed earlier. 2009 1040x Profits interest. 2009 1040x   A profits interest is a partnership interest other than a capital interest. 2009 1040x If a person receives a profits interest for providing services to, or for the benefit of, a partnership in a partner capacity or in anticipation of being a partner, the receipt of such an interest is not a taxable event for the partner or the partnership. 2009 1040x However, this does not apply in the following situations. 2009 1040x The profits interest relates to a substantially certain and predictable stream of income from partnership assets, such as income from high-quality debt securities or a high-quality net lease. 2009 1040x Within 2 years of receipt, the partner disposes of the profits interest. 2009 1040x The profits interest is a limited partnership interest in a publicly traded partnership. 2009 1040x   A profits interest transferred as compensation for services is not subject to the rules for restricted property that apply to capital interests. 2009 1040x Basis of Partner's Interest The basis of a partnership interest is the money plus the adjusted basis of any property the partner contributed. 2009 1040x If the partner must recognize gain as a result of the contribution, this gain is included in the basis of his or her interest. 2009 1040x Any increase in a partner's individual liabilities because of an assumption of partnership liabilities is considered a contribution of money to the partnership by the partner. 2009 1040x Interest acquired by gift, etc. 2009 1040x   If a partner acquires an interest in a partnership by gift, inheritance, or under any circumstance other than by a contribution of money or property to the partnership, the partner's basis must be determined using the basis rules described in Publication 551. 2009 1040x Adjusted Basis There is a worksheet for adjusting the basis of a partner's interest in the partnership in the Partner's Instructions for Schedule K-1 (Form 1065). 2009 1040x The basis of an interest in a partnership is increased or decreased by certain items. 2009 1040x Increases. 2009 1040x   A partner's basis is increased by the following items. 2009 1040x The partner's additional contributions to the partnership, including an increased share of, or assumption of, partnership liabilities. 2009 1040x The partner's distributive share of taxable and nontaxable partnership income. 2009 1040x The partner's distributive share of the excess of the deductions for depletion over the basis of the depletable property, unless the property is oil or gas wells whose basis has been allocated to partners. 2009 1040x Decreases. 2009 1040x   The partner's basis is decreased (but never below zero) by the following items. 2009 1040x The money (including a decreased share of partnership liabilities or an assumption of the partner's individual liabilities by the partnership) and adjusted basis of property distributed to the partner by the partnership. 2009 1040x The partner's distributive share of the partnership losses (including capital losses). 2009 1040x The partner's distributive share of nondeductible partnership expenses that are not capital expenditures. 2009 1040x This includes the partner's share of any section 179 expenses, even if the partner cannot deduct the entire amount on his or her individual income tax return. 2009 1040x The partner's deduction for depletion for any partnership oil and gas wells, up to the proportionate share of the adjusted basis of the wells allocated to the partner. 2009 1040x Partner's liabilities assumed by partnership. 2009 1040x   If contributed property is subject to a debt or if a partner's liabilities are assumed by the partnership, the basis of that partner's interest is reduced (but not below zero) by the liability assumed by the other partners. 2009 1040x This partner must reduce his or her basis because the assumption of the liability is treated as a distribution of money to that partner. 2009 1040x The other partners' assumption of the liability is treated as a contribution by them of money to the partnership. 2009 1040x See Effect of Partnership Liabilities , later. 2009 1040x Example 1. 2009 1040x Ivan acquired a 20% interest in a partnership by contributing property that had an adjusted basis to him of $8,000 and a $4,000 mortgage. 2009 1040x The partnership assumed payment of the mortgage. 2009 1040x The basis of Ivan's interest is: Adjusted basis of contributed property $8,000 Minus: Part of mortgage assumed by other partners (80% × $4,000) 3,200 Basis of Ivan's partnership interest $4,800 Example 2. 2009 1040x If, in Example 1, the contributed property had a $12,000 mortgage, the basis of Ivan's partnership interest would be zero. 2009 1040x The $1,600 difference between the mortgage assumed by the other partners, $9,600 (80% × $12,000), and his basis of $8,000 would be treated as capital gain from the sale or exchange of a partnership interest. 2009 1040x However, this gain would not increase the basis of his partnership interest. 2009 1040x Book value of partner's interest. 2009 1040x   The adjusted basis of a partner's interest is determined without considering any amount shown in the partnership books as a capital, equity, or similar account. 2009 1040x Example. 2009 1040x Enzo contributes to his partnership property that has an adjusted basis of $400 and a fair market value of $1,000. 2009 1040x His partner contributes $1,000 cash. 2009 1040x While each partner has increased his capital account by $1,000, which will be re
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Western Area Power Administration

The Western Area Power Administration markets hydroelectric power generated by federal dams and associated services to public entities in the Western United States.

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The 2009 1040x

2009 1040x Other Methods of Depreciation Table of Contents Topics - This chapter discusses: Useful Items - You may want to see: How To Figure the DeductionBasis Useful Life Salvage Value Methods To UseStraight Line Method Declining Balance Method Income Forecast Method How To Change Methods DispositionsSale or exchange. 2009 1040x Property not disposed of or abandoned. 2009 1040x Special rule for normal retirements from item accounts. 2009 1040x Abandoned property. 2009 1040x Single item accounts. 2009 1040x Multiple property account. 2009 1040x Topics - This chapter discusses: How to figure the deduction Methods to use How to change methods Dispositions Useful Items - You may want to see: Publication 544 Sales and Other Dispositions of Assets 551 Basis of Assets 583 Starting a Business and Keeping Records 946 How To Depreciate Property Form (and Instructions) 3115 Application for Change in Accounting Method 4562 Depreciation and Amortization Schedule C (Form 1040) Profit or Loss From Business If your property is being depreciated under ACRS, you must continue to use rules for depreciation that applied when you placed the property in service. 2009 1040x If your property qualified for MACRS, you must depreciate it under MACRS. 2009 1040x See Publication 946. 2009 1040x However, you cannot use MACRS for certain property because of special rules that exclude it from MACRS. 2009 1040x Also, you can elect to exclude certain property from being depreciated under MACRS. 2009 1040x Property that you cannot depreciate using MACRS includes: Intangible property, Property you can elect to exclude from MACRS that you properly depreciate under a method that is not based on a term of years, Certain public utility property, Any motion picture film or video tape, Any sound recording, and Certain real and personal property placed in service before 1987. 2009 1040x Intangible property. 2009 1040x   You cannot depreciate intangible property under ACRS or MACRS. 2009 1040x You depreciate intangible property using any other reasonable method, usually, the straight line method. 2009 1040x Note. 2009 1040x The cost of certain intangible property that you acquire after August 10, 1993, must be amortized over a 15-year period. 2009 1040x For more information, see chapter 12 of Publication 535. 2009 1040x Public utility property. 2009 1040x   The law excludes from MACRS any public utility property for which the taxpayer does not use a normalization method of accounting. 2009 1040x This type of property is subject to depreciation under a special rule. 2009 1040x Videocassettes. 2009 1040x   If you are in the videocassette rental business, you can depreciate those videocassettes purchased for rental. 2009 1040x You can depreciate the cost less salvage value of those videocassettes that have a useful life over one year using either: The straight line method, or The income forecast method. 2009 1040x The straight line method, salvage value, and useful life are discussed later under Methods To Use. 2009 1040x You can deduct in the year of purchase as a business expense the cost of any cassette that has a useful life of one year or less. 2009 1040x How To Figure the Deduction Two other reasonable methods can be used to figure your deduction for property not covered under ACRS or MACRS. 2009 1040x These methods are straight line and declining balance. 2009 1040x To figure depreciation using these methods, you must generally determine three things about the property you intend to depreciate. 2009 1040x They are: The basis, The useful life, and The estimated salvage value at the end of its useful life. 2009 1040x The amount of the deduction in any year also depends on which method of depreciation you choose. 2009 1040x Basis To deduct the proper amount of depreciation each year, first determine your basis in the property you intend to depreciate. 2009 1040x The basis used for figuring depreciation is the same as the basis that would be used for figuring the gain on a sale. 2009 1040x Your original basis is usually the purchase price. 2009 1040x However, if you acquire property in some other way, such as inheriting it, getting it as a gift, or building it yourself, you have to figure your original basis in a different way. 2009 1040x Adjusted basis. 2009 1040x   Events will often change the basis of property. 2009 1040x When this occurs, the changed basis is called the adjusted basis. 2009 1040x Some events, such as improvements you make, increase basis. 2009 1040x Events such as deducting casualty losses and depreciation decrease basis. 2009 1040x If basis is adjusted, the depreciation deduction may also have to be changed, depending on the reason for the adjustment and the method of depreciation you are using. 2009 1040x   Publication 551 explains how to figure basis for property acquired in different ways. 2009 1040x It also discusses what items increase and decrease basis, how to figure adjusted basis, and how to allocate cost if you buy several pieces of property at one time. 2009 1040x Useful Life The useful life of a piece of property is an estimate of how long you can expect to use it in your trade or business, or to produce income. 2009 1040x It is the length of time over which you will make yearly depreciation deductions of your basis in the property. 2009 1040x It is how long it will continue to be useful to you, not how long the property will last. 2009 1040x Many things affect the useful life of property, such as: Frequency of use, Age when acquired, Your repair policy, and Environmental conditions. 2009 1040x The useful life can also be affected by technological improvements, progress in the arts, reasonably foreseeable economic changes, shifting of business centers, prohibitory laws, and other causes. 2009 1040x Consider all these factors before you arrive at a useful life for your property. 2009 1040x The useful life of the same type of property varies from user to user. 2009 1040x When you determine the useful life of your property, keep in mind your own experience with similar property. 2009 1040x You can use the general experience of the industry you are in until you are able to determine a useful life of your property from your own experience. 2009 1040x Change in useful life. 2009 1040x   You base your estimate of useful life on certain facts. 2009 1040x If these facts change significantly, you can adjust your estimate of the remaining useful life. 2009 1040x However, you redetermine the estimated useful life only when the change is substantial and there is a clear reason for making the change. 2009 1040x Salvage Value It is important for you to accurately determine the correct salvage value of the property you want to depreciate. 2009 1040x You generally cannot depreciate property below a reasonable salvage value. 2009 1040x Determining salvage value. 2009 1040x   Salvage value is the estimated value of property at the end of its useful life. 2009 1040x It is what you expect to get for the property if you sell it after you can no longer use it productively. 2009 1040x You must estimate the salvage value of a piece of property when you first acquire it. 2009 1040x   Salvage value is affected both by how you use the property and how long you use it. 2009 1040x If it is your policy to dispose of property that is still in good operating condition, the salvage value can be relatively large. 2009 1040x However, if your policy is to use property until it is no longer usable, its salvage value can be its junk value. 2009 1040x Changing salvage value. 2009 1040x   Once you determine the salvage value for property, you should not change it merely because prices have changed. 2009 1040x However, if you redetermine the useful life of property, as discussed earlier under Change in useful life, you can also redetermine the salvage value. 2009 1040x When you redetermine the salvage value, take into account the facts that exist at the time. 2009 1040x Net salvage. 2009 1040x   Net salvage is the salvage value of property minus what it costs to remove it when you dispose of it. 2009 1040x You can choose either salvage value or net salvage when you figure depreciation. 2009 1040x You must consistently use the one you choose and the treatment of the costs of removal must be consistent with the practice adopted. 2009 1040x However, if the cost to remove the property is more than the estimated salvage value, then net salvage is zero. 2009 1040x Your salvage value can never be less than zero. 2009 1040x Ten percent rule. 2009 1040x   If you acquire personal property that has a useful life of 3 years or more, you can use an amount for salvage value that is less than your actual estimate. 2009 1040x You can subtract from your estimate of salvage value an amount equal to 10% of your basis in the property. 2009 1040x If salvage value is less than 10% of basis, you can ignore salvage value when you figure depreciation. 2009 1040x Methods To Use Two methods of depreciation are the straight line and declining balance methods. 2009 1040x If ACRS or MACRS does not apply, you can use one of these methods. 2009 1040x The straight line and declining balance methods discussed in this section are not figured in the same way as straight line or declining balance methods under MACRS. 2009 1040x Straight Line Method Before 1981, you could use any reasonable method for every kind of depreciable property. 2009 1040x One of these methods was the straight line method. 2009 1040x This method was also used for intangible property. 2009 1040x It lets you deduct the same amount of depreciation each year. 2009 1040x To figure your deduction, determine the adjusted basis of your property, its salvage value, and its estimated useful life. 2009 1040x Subtract the salvage value, if any, from the adjusted basis. 2009 1040x The balance is the total amount of depreciation you can take over the useful life of the property. 2009 1040x Divide the balance by the number of years remaining in the useful life. 2009 1040x This gives you the amount of your yearly depreciation deduction. 2009 1040x Unless there is a big change in adjusted basis, or useful life, this amount will stay the same throughout the time you depreciate the property. 2009 1040x If, in the first year, you use the property for less than a full year, you must prorate your depreciation deduction for the number of months in use. 2009 1040x Example. 2009 1040x In April 1994, Frank bought a franchise for $5,600. 2009 1040x It expires in 10 years. 2009 1040x This property is intangible property that cannot be depreciated under MACRS. 2009 1040x Frank depreciates the franchise under the straight line method, using a 10-year useful life and no salvage value. 2009 1040x He takes the $5,600 basis and divides that amount by 10 years ($5,600 ÷ 10 = $560, a full year's use). 2009 1040x He must prorate the $560 for his 9 months of use in 1994. 2009 1040x This gives him a deduction of $420 ($560 ÷ 9/12). 2009 1040x In 1995, Frank can deduct $560 for the full year. 2009 1040x Declining Balance Method The declining balance method allows you to recover a larger amount of the cost of the property in the early years of your use of the property. 2009 1040x The rate cannot be more than twice the straight line rate. 2009 1040x Rate of depreciation. 2009 1040x   Under this method, you must determine your declining balance rate of depreciation. 2009 1040x The initial step is to: Divide the number 1 by the useful life of your property to get a straight line rate. 2009 1040x (For example, if property has a useful life of 5 years, its normal straight line rate of depreciation is ⅕, or 20%. 2009 1040x ) Multiply this straight line rate by a number that is more than 1 but not more than 2 to determine the declining balance rate. 2009 1040x Unless there is a change in the useful life during the time you depreciate the property, the rate of depreciation generally will not change. 2009 1040x Depreciation deductions. 2009 1040x   After you determine the rate of depreciation, multiply the adjusted basis of the property by it. 2009 1040x This gives you the amount of your deduction. 2009 1040x For example, if your adjusted basis at the beginning of the first year is $10,000, and your declining balance rate is 20%, your depreciation deduction for the first year is $2,000 ($10,000 ÷ 20%). 2009 1040x To figure your depreciation deduction in the second year, you must first adjust the basis for the amount of depreciation you deducted in the first year. 2009 1040x Subtract the previous year's depreciation from your basis ($10,000 - $2,000 = $8,000). 2009 1040x Multiply this amount by the rate of depreciation ($8,000 ÷ 20% = $1,600). 2009 1040x Your depreciation deduction for the second year is $1,600. 2009 1040x   As you can see from this example, your adjusted basis in the property gets smaller each year. 2009 1040x Also, under this method, deductions are larger in the earlier years and smaller in the later years. 2009 1040x You can make a change to the straight line method without consent. 2009 1040x Salvage value. 2009 1040x   Do not subtract salvage value when you figure your yearly depreciation deductions under the declining balance method. 2009 1040x However, you cannot depreciate the property below its reasonable salvage value. 2009 1040x Determine salvage value using the rules discussed earlier, including the special 10% rule. 2009 1040x Example. 2009 1040x If your adjusted basis has been decreased to $1,000 and the rate of depreciation is 20%, your depreciation deduction should be $200. 2009 1040x But if your estimate of salvage value was $900, you can only deduct $100. 2009 1040x This is because $100 is the amount that would lower your adjusted basis to equal salvage value. 2009 1040x Income Forecast Method The income forecast method requires income projections for each videocassette or group of videocassettes. 2009 1040x You can group the videocassettes by title for making this projection. 2009 1040x You determine the depreciation by applying a fraction to the cost less salvage value of the cassette. 2009 1040x The numerator is the income from the videocassette for the tax year and the denominator is the total projected income for the cassette. 2009 1040x For more information on the income forecast method, see Revenue Ruling 60-358 in Cumulative Bulletin 1960, Volume 2, on page 68. 2009 1040x How To Change Methods In some cases, you may change your method of depreciation for property depreciated under a reasonable method. 2009 1040x If you change your method of depreciation, it is generally a change in your method of accounting. 2009 1040x You must get IRS consent before making the change. 2009 1040x However, you do not need permission for certain changes in your method of depreciation. 2009 1040x The rules discussed in this section do not apply to property depreciated under ACRS or MACRS. 2009 1040x For information on ACRS elections,see Revocation of election, in chapter 1 under Alternate ACRS Method. 2009 1040x Change to the straight line method. 2009 1040x   You can change from the declining balance method to the straight line method at any time during the useful life of your property without IRS consent. 2009 1040x However, if you have a written agreement with the IRS that prohibits a change, you must first get IRS permission. 2009 1040x When the change is made, figure depreciation based on your adjusted basis in the property at that time. 2009 1040x Your adjusted basis takes into account all previous depreciation deductions. 2009 1040x Use the estimated remaining useful life of your property at the time of change and its estimated salvage value. 2009 1040x   You can change from the declining balance method to straight line only on the original tax return for the year you first use the straight line method. 2009 1040x You cannot make the change on an amended return filed after the due date of the original return (including extensions). 2009 1040x   When you make the change, attach a statement to your tax return showing: When you acquired the property, Its original cost or other original basis, The total amount claimed for depreciation and other allowances since you acquired it, Its salvage value and remaining useful life, and A description of the property and its use. 2009 1040x   After you change to straight line, you cannot change back to the declining balance method or to any other method for a period of 10 years without written permission from the IRS. 2009 1040x Changes that require permission. 2009 1040x   For most other changes in method of depreciation, you must get permission from the IRS. 2009 1040x To request a change in method of depreciation, file Form 3115. 2009 1040x File the application within the first 180 days of the tax year the change is to become effective. 2009 1040x In most cases, there is a user fee that must accompany Form 3115. 2009 1040x See the instructions for Form 3115 to determine if a fee is required. 2009 1040x Changes granted automatically. 2009 1040x   The IRS automatically approves certain changes of a method of depreciation. 2009 1040x But, you must file Form 3115 for these automatic changes. 2009 1040x   However, IRS can deny permission if Form 3115 is not filed on time. 2009 1040x For more information on automatic changes, see Revenue Procedure 74-11, 1974-1 C. 2009 1040x B. 2009 1040x 420. 2009 1040x Changes for which approval is not automatic. 2009 1040x   The automatic change procedures do not apply to: Property or an account where you made a change in depreciation within the last 10 tax years (unless the change was made under the Class Life System), Class Life Asset Depreciation Range System, and Public utility property. 2009 1040x   You must request and receive permission for these changes. 2009 1040x To make the request, file Form 3115 during the first 180 days of the tax year for which you want the change to be effective. 2009 1040x Change from an improper method. 2009 1040x   If the IRS disallows the method you are using, you do not need permission to change to a proper method. 2009 1040x You can adopt the straight line method, or any other method that would have been permitted if you had used it from the beginning. 2009 1040x If you file your tax return using an improper method, but later file an amended return, you can use a proper method on the amended return without getting IRS permission. 2009 1040x However, you must file the amended return before the filing date for the next tax year. 2009 1040x Dispositions Retirement is the permanent withdrawal of depreciable property from use in your trade or business or for the production of income. 2009 1040x You can do this by selling, exchanging, or abandoning the item of property. 2009 1040x You can also withdraw it from use without disposing of it. 2009 1040x For example, you could place it in a supplies or scrap account. 2009 1040x Retirements can be either normal or abnormal depending on all facts and circumstances. 2009 1040x The rules discussed next do not apply to MACRS and ACRS property. 2009 1040x Normal retirement. 2009 1040x   A normal retirement is a permanent withdrawal of depreciable property from use if the following apply: The retirement is made within the useful life you estimated originally, and The property has reached a condition at which you customarily retire or would retire similar property from use. 2009 1040x A retirement is generally considered normal unless you can show that you retired the property because of a reason you did not consider when you originally estimated the useful life of the property. 2009 1040x Abnormal retirement. 2009 1040x   A retirement can be abnormal if you withdraw the property early or under other circumstances. 2009 1040x For example, if the property is damaged by a fire or suddenly becomes obsolete and is now useless. 2009 1040x Gain or loss on retirement. 2009 1040x   There are special rules for figuring the gain or loss on retirement of property. 2009 1040x The gain or loss will depend on several factors. 2009 1040x These include the type of withdrawal, if the withdrawal was from a single property or multiple property account, and if the retirement was normal or abnormal. 2009 1040x A single property account contains only one item of property. 2009 1040x A multiple property account is one in which several items have been combined with a single rate of depreciation assigned to the entire account. 2009 1040x Sale or exchange. 2009 1040x   If property is retired by sale or exchange, you figure gain or loss by the usual rules that apply to sales or other dispositions of property. 2009 1040x See Publication 544. 2009 1040x Property not disposed of or abandoned. 2009 1040x   If property is retired permanently, but not disposed of or physically abandoned, you do not recognize gain. 2009 1040x You are allowed a loss in such a case, but only if the retirement is: An abnormal retirement, A normal retirement from a single property account in which you determined the life of each item of property separately, or A normal retirement from a multiple property account in which the depreciation rate is based on the maximum expected life of the longest lived item of property and the loss occurs before the expiration of the full useful life. 2009 1040x However, you are not allowed a loss if the depreciation rate is based on the average useful life of the items of property in the account. 2009 1040x   To figure your loss, subtract the estimated salvage or fair market value of the property at the date of retirement, whichever is more, from its adjusted basis. 2009 1040x Special rule for normal retirements from item accounts. 2009 1040x   You can generally deduct losses upon retirement of a few depreciable items of property with similar useful lives, if: You account for each one in a separate account, and You use the average useful life to figure depreciation. 2009 1040x However, you cannot deduct losses if you use the average useful life to figure depreciation and they have a wide range of useful lives. 2009 1040x   If you have a large number of depreciable property items and use average useful lives to figure depreciation, you cannot deduct the losses upon normal retirements from these accounts. 2009 1040x Abandoned property. 2009 1040x   If you physically abandon property, you can deduct as a loss the adjusted basis of the property at the time of its abandonment. 2009 1040x However, your intent must be to discard the property so that you will not use it again or retrieve it for sale, exchange, or other disposition. 2009 1040x Basis of property retired. 2009 1040x   The basis for figuring gain or loss on the retirement of property is its adjusted basis at the time of retirement, as determined in the following discussions. 2009 1040x Single item accounts. 2009 1040x   If an item of property is accounted for in a single item account, the adjusted basis is the basis you would use to figure gain or loss for a sale or exchange of the property. 2009 1040x This is generally the cost or other basis of the item of property less depreciation. 2009 1040x See Publication 551. 2009 1040x Multiple property account. 2009 1040x   For a normal retirement from a multiple property account, if you figured depreciation using the average expected useful life, the adjusted basis is the salvage value estimated for the item of property when it was originally acquired. 2009 1040x If you figured depreciation using the maximum expected useful life of the longest lived item of property in the account, you must use the depreciation method used for the multiple property account and a rate based on the maximum expected useful life of the item of property retired. 2009 1040x   You make the adjustment for depreciation for an abnormal retirement from a multiple property account at the rate that would be proper if the item of property was depreciated in a single property account. 2009 1040x The method of depreciation used for the multiple property account is used. 2009 1040x You base the rate on either the average expected useful life or the maximum expected useful life of the retired item of property, depending on the method used to determine the depreciation rate for the multiple property account. 2009 1040x Prev  Up  Next   Home   More Online Publications