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W2 ez Publication 595 - Main Contents Table of Contents Capital Construction FundCCF Accounts Types of Accounts You Must Maintain Within a CCF Tax Treatment of CCF Deposits Tax Treatment of CCF Earnings Tax Treatment of CCF Withdrawals More Information How To Get Tax Help Capital Construction Fund The following sections discuss CCF accounts and the types of bookkeeping accounts you must maintain when you invest in a CCF account. W2 ez They also discuss the income tax treatment of CCF deposits, earnings, and withdrawals. W2 ez CCF Accounts This section explains who can open a CCF account and how to use the account to defer income tax. W2 ez Opening a CCF account. W2 ez   If you are a U. W2 ez S. W2 ez citizen and you own or lease one or more eligible vessels (defined later), you can open a CCF account. W2 ez However, before you open your CCF account, you must enter into an agreement with the Secretary of Commerce through the NMFS. W2 ez This agreement will establish the following. W2 ez Agreement vessels. W2 ez Eligible vessels named in the agreement that will be the basis for the deferral of income tax. W2 ez Planned use of withdrawals. W2 ez Use of CCF funds to acquire, build, or rebuild a vessel. W2 ez CCF depository. W2 ez Where your CCF funds will be held. W2 ez    You can request an application kit or get additional information from NMFS at the following address. W2 ez NOAA/NMFS, Financial Services Division, F/MB5 Capital Construction Fund Program 1315 East-West Highway Silver Spring, MD 20910-3282    You can obtain information on the Capital Construction Fund Program at the following website: www. W2 ez nmfs. W2 ez noaa. W2 ez gov/mb/financial_services/ccf. W2 ez htm. W2 ez    You can call NMFS to request an application kit or get additional information at (301) 713-2393 (ext. W2 ez 204). W2 ez Their fax number is (301) 713-1939. W2 ez Eligible vessels. W2 ez   There are two types of vessels that may be considered eligible, those weighing 5 tons or more and those weighing less than 5 tons. W2 ez For each type, certain requirements must be met. W2 ez Vessel weighing 5 tons or more. W2 ez   To be considered eligible, the vessel must meet all the following requirements. W2 ez Be built or rebuilt in the United States. W2 ez Be documented under the laws of the United States. W2 ez Be used commercially in the fisheries of the United States. W2 ez Be operated in the foreign or domestic commerce of the United States. W2 ez Vessel weighing less than 5 tons. W2 ez   A small vessel, weighing at least 2 net tons but less than 5 net tons, must meet all the following requirements to be considered eligible. W2 ez Be built or rebuilt in the United States. W2 ez Be owned by a U. W2 ez S. W2 ez citizen. W2 ez Have a home port in the United States. W2 ez Be used commercially in the fisheries of the United States. W2 ez Deferring tax on CCF deposits and earnings. W2 ez   You can use a CCF account to defer income tax by taking the following actions. W2 ez Making deposits to your CCF account from taxable income. W2 ez Excluding from income deposits assigned to certain accounts (discussed later). W2 ez Making withdrawals from your CCF account when you acquire, build, or rebuild fishing vessels. W2 ez Reducing the basis of fishing vessels you acquire, build, or rebuild to recapture amounts previously excluded from tax. W2 ez    Reporting requirements. W2 ez Beginning with the tax year in which you establish your agreement, you must report annual deposit and withdrawal activity to the NMFS on NOAA Form 34-82. W2 ez This form is due within 30 days after you file your federal income tax return even if no deposits or withdrawals are made. W2 ez For more information, contact the NMFS at the address or phone number given earlier. W2 ez Types of Accounts You Must Maintain Within a CCF This section discusses the three types of bookkeeping accounts you must maintain when you invest in a CCF account. W2 ez Your total CCF deposits and earnings for any given year are limited to the amount attributed to these three accounts for that year. W2 ez Capital account. W2 ez   The capital account consists primarily of amounts attributable to the following items. W2 ez Allowable depreciation deductions for agreement vessels. W2 ez Any nontaxable return of capital from either (a) or (b), below. W2 ez The sale or other disposition of agreement vessels. W2 ez Insurance or indemnity proceeds attributable to agreement vessels. W2 ez Any tax-exempt interest earned on state or local bonds in your CCF account. W2 ez Capital gain account. W2 ez   The capital gain account consists of amounts attributable to the following items reduced by any capital losses from assets held in your CCF account for more than 6 months. W2 ez Any capital gain from either of the following sources. W2 ez The sale or other disposition of agreement vessels held for more than 6 months. W2 ez Insurance or indemnity proceeds attributable to agreement vessels held for more than 6 months. W2 ez Any capital gain from assets held in your CCF account for more than 6 months. W2 ez Ordinary income account. W2 ez   The ordinary income account consists of amounts attributable to the following items. W2 ez Any earnings (without regard to the carryback of any net operating or net capital loss) from the operation of agreement vessels in the fisheries of the United States or in the foreign or domestic commerce of the United States. W2 ez Any capital gain from the following sources reduced by any capital losses from assets held in your CCF account for 6 months or less. W2 ez The sale or other disposition of agreement vessels held for 6 months or less. W2 ez Insurance or indemnity proceeds attributable to agreement vessels held for 6 months or less. W2 ez Any capital gain from assets held in your CCF account for 6 months or less. W2 ez Any ordinary income (such as depreciation recapture) from either of the following sources. W2 ez The sale or other disposition of agreement vessels. W2 ez Insurance or indemnity proceeds attributable to agreement vessels. W2 ez Any interest (not including tax-exempt interest from state and local bonds), most dividends, and other ordinary income earned on the assets in your CCF account. W2 ez Tax Treatment of CCF Deposits This section explains the tax treatment of income used as the basis for CCF deposits. W2 ez Capital gains. W2 ez   Do not report any transaction that produces a capital gain if you deposit the net proceeds into your CCF account. W2 ez This treatment applies to either of the following transactions. W2 ez The sale or other disposition of an agreement vessel. W2 ez The receipt of insurance or indemnity proceeds attributable to an agreement vessel. W2 ez Depreciation recapture. W2 ez   Do not report any transaction that produces depreciation recapture if you deposit the net proceeds into your CCF account. W2 ez This treatment applies to either of the following transactions. W2 ez The sale or other disposition of an agreement vessel. W2 ez The receipt of insurance or indemnity proceeds attributable to an agreement vessel. W2 ez Earnings from operations. W2 ez   Report earnings from the operation of agreement vessels on your Schedule C or C-EZ (Form 1040) even if you deposit part of these earnings into your CCF account. W2 ez You subtract any part of the earnings you deposited into your CCF account from the amount you would otherwise enter as taxable income on Form 1040, line 43 (for 2005). W2 ez Next to line 43, write “CCF” and the amount of the deposits. W2 ez Do not deduct these CCF deposits on Schedule C or C-EZ (Form 1040). W2 ez If you deposit earnings from operations into your CCF account and you must complete other forms such as Form 6251, Alternative Minimum Tax (Individuals), or a worksheet for Schedule D (Form 1040), you will need to make an extra computation. W2 ez When the other form instructs you to use the amount from Form 1040, line 41 (for 2005), do not use that amount. W2 ez Instead, add Form 1040, lines 42 and 43 (for 2005), and use that amount. W2 ez Self-employment tax. W2 ez   You must use your net profit or loss from your fishing business to figure your self-employment tax. W2 ez Do not reduce your net profit or loss by any earnings from operations you deposit into your CCF account. W2 ez    Partnerships and S corporations. W2 ez The deduction for partnership earnings from operations deposited into a CCF account is separately stated on Schedule K (Form 1065), line 13d, and allocated to the partners on Schedule K-1 (Form 1065), box 13 (for 2005). W2 ez   The deduction for S corporation earnings deposited into a CCF account is separately stated on Schedule K (Form 1120S), line 12d, and allocated to the shareholders on Schedule K-1 (Form 1120S), box 12 (for 2005). W2 ez Tax Treatment of CCF Earnings This section explains the tax treatment of the earnings from the assets in your CCF account when the earnings are redeposited or left in your account. W2 ez However, if you choose to withdraw the earnings in the year earned, you must generally pay income tax on them. W2 ez Capital gains. W2 ez   Do not report any capital gains from the sale of capital assets held in your CCF account. W2 ez This includes capital gain distributions reported to you on Form 1099-DIV or a substitute statement. W2 ez However, you should attach a statement to your tax return to list the payers and the amounts and to identify the capital gains as “CCF account earnings. W2 ez ” Interest and dividends. W2 ez   Do not report any ordinary income (such as interest and dividends) you earn on the assets in your CCF account. W2 ez However, you should attach a statement to your return to list the payers and the amounts and to identify them as “CCF account earnings. W2 ez ”   If you are required to file Schedule B (Form 1040), you can add these earnings to the list of payers and amounts on line 1 or line 5 and identify them as “CCF earnings. W2 ez ” Then, subtract the same amounts from the list and identify them as “CCF deposits. W2 ez ” Tax-exempt interest. W2 ez   Do not report tax-exempt interest from state or local bonds you held in your CCF account. W2 ez You are not required to report this interest on Form 1040, line 8b. W2 ez Tax Treatment of CCF Withdrawals This section discusses the tax treatment of amounts you withdraw from your CCF account during the year. W2 ez Qualified Withdrawals A qualified withdrawal from a CCF account is one that is approved by NMFS for either of the following uses. W2 ez Acquiring, building, or rebuilding qualified vessels (defined next). W2 ez Making principal payments on the mortgage of a qualified vessel. W2 ez NMFS will not approve amounts withdrawn to purchase nets not continuously attached to the vessel, such as seine nets, gill set-nets, and gill drift-nets. W2 ez NMFS will approve amounts withdrawn to purchase trawl nets. W2 ez Qualified vessel. W2 ez   This is any vessel that meets all of the following requirements. W2 ez The vessel was built or rebuilt in the United States. W2 ez The vessel is documented under the laws of the United States. W2 ez The person maintaining the CCF account agrees with the Secretary of Commerce that the vessel will be operated in United States foreign trade, Great Lakes trade, noncontiguous domestic trade, or the fisheries of the United States. W2 ez How to determine the source of qualified withdrawals. W2 ez   When you make a qualified withdrawal, the amount is treated as being withdrawn in the following order from the accounts listed below. W2 ez The capital account. W2 ez The capital gain account. W2 ez The ordinary income account. W2 ez Excluding qualified withdrawals from tax. W2 ez   Do not report on your income tax return any qualified withdrawals from your CCF account. W2 ez Reduce the depreciable basis of fishing vessels you acquire, build, or rebuild when you make a qualified withdrawal from either the capital gain or the ordinary income account. W2 ez Nonqualified Withdrawals A nonqualified withdrawal from a CCF account is generally any withdrawal that is not a qualified withdrawal. W2 ez Qualified withdrawals are defined under Qualified Withdrawals, earlier. W2 ez Examples. W2 ez   Examples of nonqualified withdrawals include the following amounts from either the ordinary income account or the capital gain account. W2 ez Amounts remaining in a CCF account upon termination of your agreement with NMFS. W2 ez Amounts you withdraw and use to make principal payments on the mortgage of a vessel if the basis of that vessel and the bases of other vessels you own have already been reduced to zero. W2 ez Amounts determined by the IRS to cause your CCF account balance to exceed the amount appropriate to meet your planned use of withdrawals. W2 ez You will generally be given 3 years to revise your plans to cover this excess balance. W2 ez Amounts you leave in your account for more than 25 years. W2 ez There is a graduated schedule under which the percentage applied to determine the amount of the nonqualified withdrawal increases from 20% in the 26th year to 100% in the 30th year. W2 ez How to determine the source of nonqualified withdrawals. W2 ez    When you make a nonqualified withdrawal from your CCF account, the amount is treated as being withdrawn in the following order from the accounts listed below. W2 ez The ordinary income account. W2 ez The capital gain account. W2 ez The capital account. W2 ez Paying tax on nonqualified withdrawals. W2 ez   In general, nonqualified withdrawals are taxed separately from your other gross income and at the highest marginal tax rate in effect for the year of withdrawal. W2 ez However, nonqualified withdrawals treated as made from the capital gain account are taxed at a rate that cannot exceed 15% for individuals and 34% for corporations. W2 ez    Partnerships and S corporations. W2 ez Taxable nonqualified partnership withdrawals are separately stated on Schedule K (Form 1065), line 20c, and allocated to the partners on Schedule K-1 (Form 1065), box 20 (for 2005). W2 ez Taxable nonqualified withdrawals by an S corporation are separately stated on Schedule K (Form 1120S), line 17d, and allocated to the shareholders on Schedule K-1 (Form 1120S), box 17. W2 ez Interest. W2 ez   You must pay interest on the additional tax due to nonqualified withdrawals that are treated as made from either the ordinary income or the capital gain account. W2 ez The interest period begins on the last date for paying tax for the year for which you deposited the amount you withdrew from your CCF account. W2 ez The period ends on the last date for paying tax for the year in which you make the nonqualified withdrawal. W2 ez The interest rate on the nonqualified withdrawal is simple interest. W2 ez The rate is subject to change annually and is published in the Federal Register. W2 ez    You also can call NMFS at (301) 713-2393 (ext. W2 ez 204) to get the current interest rate. W2 ez Interest deduction. W2 ez   You can deduct the interest you pay on a nonqualified withdrawal as a trade or business expense. W2 ez Reporting the additional tax and interest. W2 ez   Attach a statement to your income tax return showing your computation of the tax and the interest on a nonqualified withdrawal. W2 ez Include the tax and interest on Form 1040, line 63 (for 2005). W2 ez To the left of line 63, write in the amount of tax and interest and “CCF. W2 ez ” Tax benefit rule. W2 ez   If any portion of your nonqualified withdrawal is properly attributable to contributions (not earnings on the contributions) you made to the CCF account that did not reduce your tax liability for any tax year prior to the withdrawal year, the following tax treatment applies. W2 ez The part that did not reduce your tax liability for any year prior to the withdrawal year is not taxed. W2 ez That part is allowed as a net operating loss deduction. W2 ez More Information This section briefly discussed the CCF program. W2 ez For more detailed information, see the following legislative authorities. W2 ez Section 607 of the Merchant Marine Act of 1936, as amended (46 U. W2 ez S. W2 ez C. W2 ez 1177). W2 ez Chapter 2, Part 259 of title 50 of the Code of Federal Regulations (50 C. W2 ez F. W2 ez R. W2 ez , Part 259). W2 ez Subchapter A, Part 3 of title 26 of the Code of Federal Regulations (26 C. W2 ez F. W2 ez R. W2 ez , Part 3). W2 ez Section 7518 of the Internal Revenue Code (IRC 7518). W2 ez The application kit you can obtain from NMFS at the address or phone number given earlier may contain copies of some of these sources of additional information. W2 ez Also, see their web page at www. W2 ez nmfs. W2 ez noaa. W2 ez gov/mb/financial_services/ccf. W2 ez htm. W2 ez How To Get Tax Help You can get help with unresolved tax issues, order free publications and forms, ask tax questions, and get information from the IRS in several ways. W2 ez By selecting the method that is best for you, you will have quick and easy access to tax help. W2 ez Contacting your Taxpayer Advocate. W2 ez   If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate. W2 ez   The Taxpayer Advocate independently represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. W2 ez While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review. W2 ez   To contact your Taxpayer Advocate: Call the Taxpayer Advocate toll free at 1-877-777-4778, Call, write, or fax the Taxpayer Advocate office in your area, Call 1-800-829-4059 if you are a TTY/TDD user, or Visit www. W2 ez irs. W2 ez gov/advocate. W2 ez   For more information, see Publication 1546, How To Get Help With Unresolved Tax Problems (now available in Chinese, Korean, Russian, and Vietnamese, in addition to English and Spanish). W2 ez Free tax services. W2 ez   To find out what services are available, get Publication 910, IRS Guide to Free Tax Services. W2 ez It contains a list of free tax publications and an index of tax topics. W2 ez It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics. W2 ez Internet. W2 ez You can access the IRS website 24 hours a day, 7 days a week, at www. W2 ez irs. W2 ez gov to: E-file your return. W2 ez Find out about commercial tax preparation and e-file services available free to eligible taxpayers. W2 ez Check the status of your refund. W2 ez Click on Where's My Refund. W2 ez Be sure to wait at least 6 weeks from the date you filed your return (3 weeks if you filed electronically). W2 ez Have your tax return available because you will need to know your social security number, your filing status, and the exact whole dollar amount of your refund. W2 ez Download forms, instructions, and publications. W2 ez Order IRS products online. W2 ez Research your tax questions online. W2 ez Search publications online by topic or keyword. W2 ez View Internal Revenue Bulletins (IRBs) published in the last few years. W2 ez Figure your withholding allowances using our Form W-4 calculator. W2 ez Sign up to receive local and national tax news by email. W2 ez Get information on starting and operating a small business. W2 ez Phone. W2 ez Many services are available by phone. W2 ez Ordering forms, instructions, and publications. W2 ez Call 1-800-829-3676 to order current-year forms, instructions, and publications and prior-year forms and instructions. W2 ez You should receive your order within 10 days. W2 ez Asking tax questions. W2 ez Call the IRS with your tax questions at 1-800-829-1040. W2 ez Solving problems. W2 ez You can get face-to-face help solving tax problems every business day in IRS Taxpayer Assistance Centers. W2 ez An employee can explain IRS letters, request adjustments to your account, or help you set up a payment plan. W2 ez Call your local Taxpayer Assistance Center for an appointment. W2 ez To find the number, go to www. W2 ez irs. W2 ez gov/localcontacts or look in the phone book under United States Government, Internal Revenue Service. W2 ez TTY/TDD equipment. W2 ez If you have access to TTY/TDD equipment, call 1-800-829-4059 to ask tax questions or to order forms and publications. W2 ez TeleTax topics. W2 ez Call 1-800-829-4477 and press 2 to listen to pre-recorded messages covering various tax topics. W2 ez Refund information. W2 ez If you would like to check the status of your refund, call 1-800-829-4477 and press 1 for automated refund information and follow the recorded instructions or call 1-800-829-1954. W2 ez Be sure to wait at least 6 weeks from the date you filed your return (3 weeks if you filed electronically). W2 ez Have your tax return available because you will need to know your social security number, your filing status, and the exact whole dollar amount of your refund. W2 ez Evaluating the quality of our telephone services. W2 ez To ensure that IRS representatives give accurate, courteous, and professional answers, we use several methods to evaluate the quality of our telephone services. W2 ez One method is for a second IRS representative to sometimes listen in on or record telephone calls. W2 ez Another is to ask some callers to complete a short survey at the end of the call. W2 ez Walk-in. W2 ez Many products and services are available on a walk-in basis. W2 ez Products. W2 ez You can walk in to many post offices, libraries, and IRS offices to pick up certain forms, instructions, and publications. W2 ez Some IRS offices, libraries, grocery stores, copy centers, city and county government offices, credit unions, and office supply stores have a collection of products available to print from a CD-ROM or photocopy from reproducible proofs. W2 ez Also, some IRS offices and libraries have the Internal Revenue Code, regulations, Internal Revenue Bulletins, and Cumulative Bulletins available for research purposes. W2 ez Services. W2 ez You can walk in to your local Taxpayer Assistance Center every business day for personal, face-to-face tax help. W2 ez An employee can explain IRS letters, request adjustments to your account, or help you set up a payment plan. W2 ez If you need to resolve a tax problem, have questions about how the tax law applies to your individual tax return, or you're more comfortable talking with someone in person, visit your local Taxpayer Assistance Center where you can spread out your records and talk with an IRS representative face-to-face. W2 ez No appointment is necessary, but if you prefer, you can call your local Center and leave a message requesting an appointment to resolve a tax account issue. W2 ez A representative will call you back within 2 business days to schedule an in-person appointment at your convenience. W2 ez To find the number, go to www. W2 ez irs. W2 ez gov/localcontacts or look in the phone book under United States Government, Internal Revenue Service. W2 ez Mail. W2 ez You can send your order for forms, instructions, and publications to the address below and receive a response within 10 business days after your request is received. W2 ez National Distribution Center P. W2 ez O. W2 ez Box 8903 Bloomington, IL 61702-8903 CD-ROM for tax products. W2 ez You can order Publication 1796, IRS Tax Products on CD-ROM, and obtain: A CD that is released twice so you have the latest products. W2 ez The first release ships in late December and the final release ships in late February. W2 ez Current-year forms, instructions, and publications. W2 ez Prior-year forms, instructions, and publications. W2 ez Tax Map: an electronic research tool and finding aid. W2 ez Tax law frequently asked questions (FAQs). W2 ez Tax Topics from the IRS telephone response system. W2 ez Fill-in, print, and save features for most tax forms. W2 ez Internal Revenue Bulletins. W2 ez Toll-free and email technical support. W2 ez Buy the CD-ROM from National Technical Information Service (NTIS) at www. W2 ez irs. W2 ez gov/cdorders for $25 (no handling fee) or call 1-877-233-6767 toll free to buy the CD-ROM for $25 (plus a $5 handling fee). W2 ez CD-ROM for small businesses. W2 ez Publication 3207, Small Business Resource Guide CD-ROM, has a new look and enhanced navigation features. W2 ez This CD includes: Helpful information, such as how to prepare a business plan, find financing for your business, and much more. W2 ez All the business tax forms, instructions, and publications needed to successfully manage a business. W2 ez Tax law changes. W2 ez IRS Tax Map to help you find forms, instructions, and publications by searching on a keyword or topic. W2 ez Web links to various government agencies, business associations, and IRS organizations. W2 ez “Rate the Product” survey—your opportunity to suggest changes for future editions. W2 ez An updated version of this CD is available each year in early April. W2 ez You can get a free copy by calling 1-800-829-3676 or by visiting www. W2 ez irs. W2 ez gov/smallbiz. W2 ez Prev  Up  Next   Home   More Online Publications
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Understanding your CP504 Notice

You have an unpaid amount due on your account. If you do not pay the amount due immediately, the IRS will seize (levy) your state income tax refund and apply it to pay the amount you owe.

Printable samples of this notice (PDF)

Tax publications you may find useful

How to get help

Calling the 1-800 number listed on the top right corner of your notice is the fastest way to get your questions answered.

You can also authorize someone (such as an accountant) to contact the IRS on your behalf using this Power of Attorney and Declaration of Representative (Form 2848).

Or you may qualify for help from a Low Income Taxpayer Clinic.
 


What you need to do

  • Read your notice carefully — it explains your due date, amount due, and payment options.
  • Make your payment by your due date. Go to the payments page to find out more about your payment options.

You may want to...


Answers to Common Questions

What is the notice telling me?
This notice is telling you that we intend to issue a levy against your state tax refund because you still have a balance due on one of your tax accounts. You must pay this amount immediately to avoid this. It is also telling you that we will begin searching for other assets on which to issue a levy. We may also file a Federal Tax Lien, if we have not already done so.

What do I have to do?
Pay the amount due shown on the notice. Mail us your payment in the envelope we sent you. Include the bottom part of the notice to make sure we correctly credit your account.

If you can't pay the whole amount now, call us at the number printed at the top of the notice to see if you qualify for an installment agreement.

How much time do I have?
You must pay your balance due by the due date shown on your notice.

What happens if I don't pay or contact the IRS?
If you don't pay the amount due, we may seize ("levy") any state tax refund to which you're entitled. This is your notice of intent to levy as required by Internal Revenue Code section 6331(d).

If you still have an outstanding balance after we seize ("levy") your state tax refund, we may send you a notice giving you a right to a hearing before the IRS Office of Appeals, if you have not already received such a notice. We may then seize ("levy") or take possession of your other property or your rights to property. Property includes:

  • Wages, real estate commissions, and other income
  • Bank accounts
  • Business assets
  • Personal assets (including your car and home)
  • Social Security benefits

If you don't pay the amount due or call us to make payment arrangements, we can file a Notice of Federal Tax Lien on your property at any time, if we haven’t already done so.

If the lien is in place, you may find it difficult to sell or borrow against your property. The tax lien would also appear on your credit report ― which may harm your credit rating ― and your creditors would also be publicly notified that the IRS has priority to seize your property.

Who should I contact?
If you have any questions about the notice, call us at the number printed at the top of the notice. A customer service representative will assist you.

What if I don't agree or have already taken corrective action?
If you do not agree with this notice, contact us immediately at the number printed at the top of the notice. We will do our best to help you. If you have already paid this liability or arranged to pay it with an installment agreement, you should still call us at the number printed at the top of the notice to make sure your account reflects this.

Page Last Reviewed or Updated: 05-Mar-2014

The W2 Ez

W2 ez 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. W2 ez 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. W2 ez 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. W2 ez 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. W2 ez However, a joint undertaking merely to share expenses is not a partnership. W2 ez For example, co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants. W2 ez The rules you must use to determine whether an organization is classified as a partnership changed for organizations formed after 1996. W2 ez Organizations formed after 1996. W2 ez   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. W2 ez An organization formed under a federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic. W2 ez An organization formed under a state law that refers to it as a joint-stock company or joint-stock association. W2 ez An insurance company. W2 ez Certain banks. W2 ez An organization wholly owned by a state, local, or foreign government. W2 ez An organization specifically required to be taxed as a corporation by the Internal Revenue Code (for example, certain publicly traded partnerships). W2 ez Certain foreign organizations identified in section 301. W2 ez 7701-2(b)(8) of the regulations. W2 ez A tax-exempt organization. W2 ez A real estate investment trust. W2 ez An organization classified as a trust under section 301. W2 ez 7701-4 of the regulations or otherwise subject to special treatment under the Internal Revenue Code. W2 ez Any other organization that elects to be classified as a corporation by filing Form 8832. W2 ez For more information, see the instructions for Form 8832. W2 ez Limited liability company. W2 ez   A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC. W2 ez Unlike a partnership, none of the members of an LLC are personally liable for its debts. W2 ez 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. W2 ez 7701-3. W2 ez See Form 8832 and section 301. W2 ez 7701-3 of the regulations for more details. W2 ez A domestic LLC with at least two members that does not file Form 8832 is classified as a partnership for federal income tax purposes. W2 ez Organizations formed before 1997. W2 ez   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. W2 ez Community property. W2 ez    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. W2 ez 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. W2 ez A change in reporting position will be treated for federal tax purposes as a conversion of the entity. W2 ez   A qualified entity is a business entity that meets all the following requirements. W2 ez 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. W2 ez No person other than one or both spouses would be considered an owner for federal tax purposes. W2 ez The business entity is not treated as a corporation. W2 ez   For more information about community property, see Publication 555, Community Property. W2 ez Publication 555 discusses the community property laws of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. W2 ez Family Partnership Members of a family can be partners. W2 ez However, family members (or any other person) will be recognized as partners only if one of the following requirements is met. W2 ez 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. W2 ez If capital is not a material income-producing factor, they joined together in good faith to conduct a business. W2 ez 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. W2 ez Capital is material. W2 ez   Capital is a material income-producing factor if a substantial part of the gross income of the business comes from the use of capital. W2 ez Capital is ordinarily an income-producing factor if the operation of the business requires substantial inventories or investments in plants, machinery, or equipment. W2 ez Capital is not material. W2 ez   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. W2 ez Capital interest. W2 ez   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. W2 ez The owner withdraws from the partnership. W2 ez The partnership liquidates. W2 ez   The mere right to share in earnings and profits is not a capital interest in the partnership. W2 ez Gift of capital interest. W2 ez   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. W2 ez It must be figured by reducing the partnership income by reasonable compensation for services the donor renders to the partnership. W2 ez 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. W2 ez Purchase. W2 ez   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. W2 ez The fair market value of the purchased interest is considered donated capital. W2 ez For this purpose, members of a family include only spouses, ancestors, and lineal descendants (or a trust for the primary benefit of those persons). W2 ez Example. W2 ez A father sold 50% of his business to his son. W2 ez The resulting partnership had a profit of $60,000. W2 ez Capital is a material income-producing factor. W2 ez The father performed services worth $24,000, which is reasonable compensation, and the son performed no services. W2 ez The $24,000 must be allocated to the father as compensation. W2 ez 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. W2 ez The son's share of partnership profit cannot be more than $18,000. W2 ez Business owned and operated by spouses. W2 ez   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. W2 ez If so, they should report income or loss from the business on Form 1065. W2 ez They should not report the income on a Schedule C (Form 1040) in the name of one spouse as a sole proprietor. W2 ez However, the spouses can elect not to treat the joint venture as a partnership by making a Qualified Joint Venture Election. W2 ez Qualified Joint Venture Election. W2 ez   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. W2 ez 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. W2 ez   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. W2 ez All items of income, gain, deduction, loss, and credit are divided between the spouses based on their respective interests in the venture. W2 ez Each spouse takes into account his or her respective share of these items as a sole proprietor. W2 ez Each spouse would account for his or her respective share on the appropriate form, such as Schedule C (Form 1040). W2 ez 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. W2 ez e. W2 ez , based on their respective interests in the venture). W2 ez   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. W2 ez Each spouse should include his or her respective share of self-employment income on a separate Schedule SE (Form 1040), Self-Employment Tax. W2 ez   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. W2 ez However, this may not be true if either spouse exceeds the social security tax limitation. W2 ez   For more information on qualified joint ventures, go to IRS. W2 ez gov, enter “Election for Qualified Joint Ventures” in the search box and select the link reading “Election for Husband and Wife Unincorporated Businesses. W2 ez ” Partnership Agreement The partnership agreement includes the original agreement and any modifications. W2 ez The modifications must be agreed to by all partners or adopted in any other manner provided by the partnership agreement. W2 ez The agreement or modifications can be oral or written. W2 ez 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. W2 ez This filing date does not include any extension of time. W2 ez If the partnership agreement or any modification is silent on any matter, the provisions of local law are treated as part of the agreement. W2 ez Terminating a Partnership A partnership terminates when one of the following events takes place. W2 ez 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. W2 ez 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. W2 ez 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. W2 ez See section 1. W2 ez 708-1(b) of the regulations for more information on the termination of a partnership. W2 ez For special rules that apply to a merger, consolidation, or division of a partnership, see sections 1. W2 ez 708-1(c) and 1. W2 ez 708-1(d) of the regulations. W2 ez Date of termination. W2 ez   The partnership's tax year ends on the date of termination. W2 ez For the event described in (1), above, the date of termination is the date the partnership completes the winding up of its affairs. W2 ez 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. W2 ez Short period return. W2 ez   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. W2 ez The return is due the 15th day of the fourth month following the date of termination. W2 ez See Partnership Return (Form 1065), later, for information about filing Form 1065. W2 ez Conversion of partnership into limited liability company (LLC). W2 ez   The conversion of a partnership into an LLC classified as a partnership for federal tax purposes does not terminate the partnership. W2 ez 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. W2 ez   However, the conversion may change some of the partners' bases in their partnership interests if the partnership has recourse liabilities that become nonrecourse liabilities. W2 ez Because the partners share recourse and nonrecourse liabilities differently, their bases must be adjusted to reflect the new sharing ratios. W2 ez If a decrease in a partner's share of liabilities exceeds the partner's basis, he or she must recognize gain on the excess. W2 ez For more information, see Effect of Partnership Liabilities under Basis of Partner's Interest, later. W2 ez   The same rules apply if an LLC classified as a partnership is converted into a partnership. W2 ez IRS e-file (Electronic Filing) Please click here for the text description of the image. W2 ez 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). W2 ez Other partnerships generally have the option to file electronically. W2 ez For details about IRS e-file, see the Form 1065 instructions. W2 ez 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. W2 ez 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. W2 ez 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. W2 ez 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. W2 ez Investing partnership. W2 ez   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. W2 ez They own the property as co-owners. W2 ez They reserve the right separately to take or dispose of their shares of any property acquired or retained. W2 ez They do not actively conduct business or irrevocably authorize some person acting in a representative capacity to purchase, sell, or exchange the investment property. W2 ez 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. W2 ez Operating agreement partnership. W2 ez   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. W2 ez They own the property as co-owners, either in fee or under lease or other form of contract granting exclusive operating rights. W2 ez They reserve the right separately to take in kind or dispose of their shares of any property produced, extracted, or used. W2 ez They do not jointly sell services or the property produced or extracted. W2 ez 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. W2 ez 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. W2 ez Electing the exclusion. W2 ez   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. W2 ez This filing date includes any extension of time. W2 ez See Regulations section 1. W2 ez 761-2(b) for the procedures to follow. W2 ez 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. W2 ez The partnership return must show the names and addresses of each partner and each partner's distributive share of taxable income. W2 ez The return must be signed by a general partner. W2 ez If a limited liability company is treated as a partnership, it must file Form 1065 and one of its members must sign the return. W2 ez 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. W2 ez See the Instructions for Form 1065 for more information about who must file Form 1065. W2 ez Partnership Distributions Partnership distributions include the following. W2 ez A withdrawal by a partner in anticipation of the current year's earnings. W2 ez A distribution of the current year's or prior years' earnings not needed for working capital. W2 ez A complete or partial liquidation of a partner's interest. W2 ez A distribution to all partners in a complete liquidation of the partnership. W2 ez A partnership distribution is not taken into account in determining the partner's distributive share of partnership income or loss. W2 ez 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. W2 ez 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. W2 ez Effect on partner's basis. W2 ez   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. W2 ez See Adjusted Basis under Basis of Partner's Interest, later. W2 ez Effect on partnership. W2 ez   A partnership generally does not recognize any gain or loss because of distributions it makes to partners. W2 ez The partnership may be able to elect to adjust the basis of its undistributed property. W2 ez Certain distributions treated as a sale or exchange. W2 ez   When a partnership distributes the following items, the distribution may be treated as a sale or exchange of property rather than a distribution. W2 ez Unrealized receivables or substantially appreciated inventory items distributed in exchange for any part of the partner's interest in other partnership property, including money. W2 ez Other property (including money) distributed in exchange for any part of a partner's interest in unrealized receivables or substantially appreciated inventory items. W2 ez   See Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. W2 ez   This treatment does not apply to the following distributions. W2 ez A distribution of property to the partner who contributed the property to the partnership. W2 ez 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. W2 ez Substantially appreciated inventory items. W2 ez   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. W2 ez 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. W2 ez 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. W2 ez Any gain recognized is generally treated as capital gain from the sale of the partnership interest on the date of the distribution. W2 ez 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. W2 ez For exceptions to these rules, see Distribution of partner's debt and Net precontribution gain, later. W2 ez Also, see Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. W2 ez Example. W2 ez The adjusted basis of Jo's partnership interest is $14,000. W2 ez 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. W2 ez Because the cash received does not exceed the basis of her partnership interest, Jo does not recognize any gain on the distribution. W2 ez Any gain on the land will be recognized when she sells or otherwise disposes of it. W2 ez The distribution decreases the adjusted basis of Jo's partnership interest to $4,000 [$14,000 − ($8,000 + $2,000)]. W2 ez Marketable securities treated as money. W2 ez   Generally, a marketable security distributed to a partner is treated as money in determining whether gain is recognized on the distribution. W2 ez 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. W2 ez   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). W2 ez   For more information, including the definition of marketable securities, see section 731(c) of the Internal Revenue Code. W2 ez Loss on distribution. W2 ez   A partner does not recognize loss on a partnership distribution unless all the following requirements are met. W2 ez The adjusted basis of the partner's interest in the partnership exceeds the distribution. W2 ez The partner's entire interest in the partnership is liquidated. W2 ez The distribution is in money, unrealized receivables, or inventory items. W2 ez   There are exceptions to these general rules. W2 ez See the following discussions. W2 ez Also, see Liquidation at Partner's Retirement or Death under Disposition of Partner's Interest, later. W2 ez Distribution of partner's debt. W2 ez   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). W2 ez   The partner is treated as having satisfied the debt for its fair market value. W2 ez 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. W2 ez   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. W2 ez Net precontribution gain. W2 ez   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. W2 ez   The gain recognized is the lesser of the following amounts. W2 ez 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. W2 ez The “net precontribution gain” of the partner. W2 ez 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. W2 ez For information about the distribution of contributed property to another partner, see Contribution of Property , under Transactions Between Partnership and Partners, later. W2 ez   The character of the gain is determined by reference to the character of the net precontribution gain. W2 ez 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. W2 ez For these rules, the term “money” includes marketable securities treated as money, as discussed earlier. W2 ez Effect on basis. W2 ez   The adjusted basis of the partner's interest in the partnership is increased by any net precontribution gain recognized by the partner. W2 ez Other than for purposes of determining the gain, the increase is treated as occurring immediately before the distribution. W2 ez See Basis of Partner's Interest , later. W2 ez   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. W2 ez Exceptions. W2 ez   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. W2 ez 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. W2 ez   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. W2 ez 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. W2 ez 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. W2 ez Example 1. W2 ez The adjusted basis of Emily's partnership interest is $30,000. W2 ez She receives a distribution of property that has an adjusted basis of $20,000 to the partnership and $4,000 in cash. W2 ez Her basis for the property is $20,000. W2 ez Example 2. W2 ez The adjusted basis of Steve's partnership interest is $10,000. W2 ez He receives a distribution of $4,000 cash and property that has an adjusted basis to the partnership of $8,000. W2 ez His basis for the distributed property is limited to $6,000 ($10,000 − $4,000, the cash he receives). W2 ez Complete liquidation of partner's interest. W2 ez   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. W2 ez Partner's holding period. W2 ez   A partner's holding period for property distributed to the partner includes the period the property was held by the partnership. W2 ez If the property was contributed to the partnership by a partner, then the period it was held by that partner is also included. W2 ez Basis divided among properties. W2 ez   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. W2 ez For property distributed after August 5, 1997, allocate the basis using the following rules. W2 ez 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. W2 ez If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. W2 ez 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. W2 ez If the allocable basis exceeds the total of these assigned bases, increase the assigned bases by the amount of the excess. W2 ez If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. W2 ez Allocating a basis increase. W2 ez   Allocate any basis increase required in rule (2), above, first to properties with unrealized appreciation to the extent of the unrealized appreciation. W2 ez 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. W2 ez Allocate any remaining basis increase among all the properties in proportion to their respective fair market values. W2 ez Example. W2 ez Eun's basis in her partnership interest is $55,000. W2 ez In a distribution in liquidation of her entire interest, she receives properties A and B, neither of which is inventory or unrealized receivables. W2 ez Property A has an adjusted basis to the partnership of $5,000 and a fair market value of $40,000. W2 ez Property B has an adjusted basis to the partnership of $10,000 and a fair market value of $10,000. W2 ez 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). W2 ez This leaves a $40,000 basis increase (the $55,000 allocable basis minus the $15,000 total of the assigned bases). W2 ez She first allocates $35,000 to property A (its unrealized appreciation). W2 ez The remaining $5,000 is allocated between the properties based on their fair market values. W2 ez $4,000 ($40,000/$50,000) is allocated to property A and $1,000 ($10,000/$50,000) is allocated to property B. W2 ez 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). W2 ez Allocating a basis decrease. W2 ez   Use the following rules to allocate any basis decrease required in rule (1) or rule (2), earlier. W2 ez Allocate the basis decrease first to items with unrealized depreciation to the extent of the unrealized depreciation. W2 ez 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. W2 ez Allocate any remaining basis decrease among all the items in proportion to their respective assigned basis amounts (as decreased in (1)). W2 ez Example. W2 ez Armando's basis in his partnership interest is $20,000. W2 ez In a distribution in liquidation of his entire interest, he receives properties C and D, neither of which is inventory or unrealized receivables. W2 ez Property C has an adjusted basis to the partnership of $15,000 and a fair market value of $15,000. W2 ez Property D has an adjusted basis to the partnership of $15,000 and a fair market value of $5,000. W2 ez 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). W2 ez This leaves a $10,000 basis decrease (the $30,000 total of the assigned bases minus the $20,000 allocable basis). W2 ez He allocates the entire $10,000 to property D (its unrealized depreciation). W2 ez Armando's basis in property C is $15,000 and his basis in property D is $5,000 ($15,000 − $10,000). W2 ez Distributions before August 6, 1997. W2 ez   For property distributed before August 6, 1997, allocate the basis using the following rules. W2 ez 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. W2 ez 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. W2 ez Allocate any remaining basis to other distributed properties in proportion to their adjusted bases to the partnership. W2 ez Partner's interest more than partnership basis. W2 ez   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. W2 ez Special adjustment to basis. W2 ez   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. W2 ez To choose the special adjustment, the partner must have received the distribution within 2 years after acquiring the partnership interest. W2 ez Also, the partnership must not have chosen the optional adjustment to basis when the partner acquired the partnership interest. W2 ez   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. W2 ez 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. W2 ez   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. W2 ez 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. W2 ez   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. W2 ez 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. W2 ez Example. W2 ez Chin Ho purchased a 25% interest in X partnership for $17,000 cash. W2 ez 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. W2 ez 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. W2 ez 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. W2 ez The value of the inventory received was 25% of the value of all partnership inventory. W2 ez (It is immaterial whether the inventory he received was on hand when he acquired his interest. W2 ez ) 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. W2 ez 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). W2 ez 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. W2 ez 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). W2 ez His basis in the inventory items is $4,000 ($3,500 partnership basis + $500 special adjustment). W2 ez The remaining $11,500 is allocated to his new basis for the other property he received. W2 ez Mandatory adjustment. W2 ez   A partner does not always have a choice of making this special adjustment to basis. W2 ez 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. W2 ez The fair market value of all partnership property (other than money) was more than 110% of its adjusted basis to the partnership. W2 ez 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. W2 ez The optional basis adjustment, if it had been chosen by the partnership, would have changed the partner's basis for the property actually distributed. W2 ez Required statement. W2 ez   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. W2 ez The statement must provide information necessary for the partner to compute the special basis adjustment. W2 ez Marketable securities. W2 ez   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. W2 ez See Marketable securities treated as money under Partner's Gain or Loss, earlier. W2 ez The basis increase is allocated among the securities in proportion to their respective amounts of unrealized appreciation before the basis increase. W2 ez 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. W2 ez These transactions include the following. W2 ez 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. W2 ez 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. W2 ez Payments by accrual basis partnership to cash basis partner. W2 ez   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. W2 ez However, this rule does not apply to guaranteed payments made to a partner, which are generally deductible when accrued. W2 ez Guaranteed Payments Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. W2 ez 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. W2 ez This treatment is for purposes of determining gross income and deductible business expenses only. W2 ez For other tax purposes, guaranteed payments are treated as a partner's distributive share of ordinary income. W2 ez Guaranteed payments are not subject to income tax withholding. W2 ez The partnership generally deducts guaranteed payments on line 10 of Form 1065 as a business expense. W2 ez They are also listed on Schedules K and K-1 of the partnership return. W2 ez 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. W2 ez Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenses. W2 ez Generally, organizational and syndication expenses are not deductible by the partnership. W2 ez 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). W2 ez 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. W2 ez Minimum payment. W2 ez   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. W2 ez Example. W2 ez Under a partnership agreement, Divya is to receive 30% of the partnership income, but not less than $8,000. W2 ez The partnership has net income of $20,000. W2 ez Divya's share, without regard to the minimum guarantee, is $6,000 (30% × $20,000). W2 ez The guaranteed payment that can be deducted by the partnership is $2,000 ($8,000 − $6,000). W2 ez 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. W2 ez 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. W2 ez Self-employed health insurance premiums. W2 ez   Premiums for health insurance paid by a partnership on behalf of a partner, for services as a partner, are treated as guaranteed payments. W2 ez The partnership can deduct the payments as a business expense, and the partner must include them in gross income. W2 ez 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. W2 ez   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. W2 ez 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. W2 ez For more information on the self-employed health insurance deduction, see chapter 6 in Publication 535. W2 ez Including payments in partner's income. W2 ez   Guaranteed payments are included in income in the partner's tax year in which the partnership's tax year ends. W2 ez Example 1. W2 ez 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. W2 ez Her distributive share of the partnership income is 10%. W2 ez The partnership has $50,000 of ordinary income after deducting the guaranteed payment. W2 ez 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. W2 ez Example 2. W2 ez Lamont is a calendar year taxpayer who is a partner in a partnership. W2 ez The partnership uses a fiscal year that ended January 31, 2013. W2 ez Lamont received guaranteed payments from the partnership from February 1, 2012, until December 31, 2012. W2 ez He must include these guaranteed payments in income for 2013 and report them on his 2013 income tax return. W2 ez Payments resulting in loss. W2 ez   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. W2 ez 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. W2 ez Sale or Exchange of Property Special rules apply to a sale or exchange of property between a partnership and certain persons. W2 ez Losses. W2 ez   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%. W2 ez   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. W2 ez   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. W2 ez   If the purchaser later sells the property, only the gain realized that is greater than the loss not allowed will be taxable. W2 ez 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. W2 ez Gains. W2 ez   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. W2 ez More than 50% of the capital or profits interest in the partnership(s) is directly or indirectly owned by the same person(s). W2 ez The property in the hands of the transferee immediately after the transfer is not a capital asset. W2 ez 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. W2 ez More than 50% ownership. W2 ez   To determine if there is more than 50% ownership in partnership capital or profits, the following rules apply. W2 ez 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. W2 ez An individual is considered to own the interest directly or indirectly owned by, or for, the individual's family. W2 ez For this rule, “family” includes only brothers, sisters, half-brothers, half-sisters, spouses, ancestors, and lineal descendants. W2 ez 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. W2 ez 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. W2 ez Example. W2 ez Individuals A and B and Trust T are equal partners in Partnership ABT. W2 ez A's husband, AH, is the sole beneficiary of Trust T. W2 ez Trust T's partnership interest will be attributed to AH only for the purpose of further attributing the interest to A. W2 ez As a result, A is a more-than-50% partner. W2 ez 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. W2 ez More information. W2 ez   For more information on these special rules, see Sales and Exchanges Between Related Persons in chapter 2 of Publication 544. W2 ez 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. W2 ez This applies whether a partnership is being formed or is already operating. W2 ez The partnership's holding period for the property includes the partner's holding period. W2 ez 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. W2 ez The exchange is not subject to the rules explained later under Disposition of Partner's Interest. W2 ez Disguised sales. W2 ez   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. W2 ez The distribution would not have been made but for the contribution. W2 ez The partner's right to the distribution does not depend on the success of partnership operations. W2 ez   All facts and circumstances are considered in determining if the contribution and distribution are more properly characterized as a sale. W2 ez 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. W2 ez 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. W2 ez Form 8275 required. W2 ez   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. W2 ez For exceptions to this requirement, see section 1. W2 ez 707-3(c)(2) of the regulations. W2 ez   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. W2 ez   Form 8275 must include the following information. W2 ez A caption identifying the statement as a disclosure under section 707 of the Internal Revenue Code. W2 ez A description of the transferred property or money, including its value. W2 ez A description of any relevant facts in determining if the transfers are properly viewed as a disguised sale. W2 ez See section 1. W2 ez 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. W2 ez Contribution to partnership treated as investment company. W2 ez   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. W2 ez   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. W2 ez These items include money, stocks and other equity interests in a corporation, and interests in regulated investment companies and real estate investment trusts. W2 ez For more information, see section 351(e)(1) of the Internal Revenue Code and the related regulations. W2 ez Whether a partnership is treated as an investment company under this test is ordinarily determined immediately after the transfer of property. W2 ez   This rule applies to limited partnerships and general partnerships, regardless of whether they are privately formed or publicly syndicated. W2 ez Contribution to foreign partnership. W2 ez   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. W2 ez Immediately after the contribution, the partnership owned, directly or indirectly, at least a 10% interest in the foreign partnership. W2 ez 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. W2 ez   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. W2 ez See the form instructions for more information. W2 ez Basis of contributed property. W2 ez   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. W2 ez Allocations to account for built-in gain or loss. W2 ez   The fair market value of property at the time it is contributed may be different from the partner's adjusted basis. W2 ez 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. W2 ez This rule also applies to contributions of accounts payable and other accrued but unpaid items of a cash basis partner. W2 ez   The partnership can use different allocation methods for different items of contributed property. W2 ez A single reasonable method must be consistently applied to each item, and the overall method or combination of methods must be reasonable. W2 ez See section 1. W2 ez 704-3 of the regulations for allocation methods generally considered reasonable. W2 ez   If the partnership sells contributed property and recognizes gain or loss, built-in gain or loss is allocated to the contributing partner. W2 ez 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. W2 ez 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. W2 ez Example. W2 ez Areta and Sofia formed an equal partnership. W2 ez 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. W2 ez The partnership's basis for depreciation is limited to the adjusted basis of the property in Sofia's hands, $4,000. W2 ez In effect, Areta purchased an undivided one-half interest in the depreciable property with her contribution of $10,000. W2 ez 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. W2 ez To simplify this example, the depreciation deductions are determined without regard to any first-year depreciation conventions. W2 ez 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. W2 ez The entire $400 must be allocated to Areta. W2 ez Distribution of contributed property to another partner. W2 ez   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. W2 ez   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. W2 ez This amount is the difference between the property's basis and its fair market value at the time of contribution. W2 ez 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. W2 ez 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. W2 ez Disposition of certain contributed property. W2 ez   The following rules determine the character of the partnership's gain or loss on a disposition of certain types of contributed property. W2 ez Unrealized receivables. W2 ez 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. W2 ez Unrealized receivables are defined later under Payments for Unrealized Receivables and Inventory Items. W2 ez When reading the definition, substitute “partner” for “partnership. W2 ez ” Inventory items. W2 ez 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. W2 ez Inventory items are defined later in Payments for Unrealized Receivables and Inventory Items. W2 ez Capital loss property. W2 ez 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. W2 ez 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. W2 ez Substituted basis property. W2 ez 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. W2 ez Contribution of Services A partner can acquire an interest in partnership capital or profits as compensation for services performed or to be performed. W2 ez Capital interest. W2 ez   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. W2 ez This determination generally is made at the time of receipt of the partnership interest. W2 ez 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. W2 ez The capital interest transferred as compensation for services is subject to the rules for restricted property discussed in Publication 525 under Employee Compensation. W2 ez   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. W2 ez Profits interest. W2 ez   A profits interest is a partnership interest other than a capital interest. W2 ez 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. W2 ez However, this does not apply in the following situations. W2 ez 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. W2 ez Within 2 years of receipt, the partner disposes of the profits interest. W2 ez The profits interest is a limited partnership interest in a publicly traded partnership. W2 ez   A profits interest transferred as compensation for services is not subject to the rules for restricted property that apply to capital interests. W2 ez Basis of Partner's Interest The basis of a partnership interest is the money plus the adjusted basis of any property the partner contributed. W2 ez If the partner must recognize gain as a result of the contribution, this gain is included in the basis of his or her interest. W2 ez 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. W2 ez Interest acquired by gift, etc. W2 ez   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. W2 ez 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). W2 ez The basis of an interest in a partnership is increased or decreased by certain items. W2 ez Increases. W2 ez   A partner's basis is increased by the following items. W2 ez The partner's additional contributions to the partnership, including an increased share of, or assumption of, partnership liabilities. W2 ez The partner's distributive share of taxable and nontaxable partnership income. W2 ez 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. W2 ez Decreases. W2 ez   The partner's basis is decreased (but never below zero) by the following items. W2 ez 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. W2 ez The partner's distributive share of the partnership losses (including capital losses). W2 ez The partner's distributive share of nondeductible partnership expenses that are not capital expenditures. W2 ez 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. W2 ez 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. W2 ez Partner's liabilities assumed by partnership. W2 ez   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. W2 ez This partner must reduce his or her basis because the assumption of the liability is treated as a distribution of money to that partner. W2 ez The other partners' assumption of the liability is treated as a contribution by them of money to the partnership. W2 ez See Effect of Partnership Liabilities , later. W2 ez Example 1. W2 ez 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. W2 ez The partnership assumed payment of the mortgage. W2 ez 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. W2 ez If, in Example 1, the contributed property had a $12,000 mortgage, the basis of Ivan's partnership interest would be zero. W2 ez 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. W2 ez However, this gain would not increase the basis of his partnership interest. W2 ez Book value of partner's interest. W2 ez   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. W2 ez Example. W2 ez Enzo contributes to his partnership property that has an adjusted basis of $400 and a fair market value of $1,000. W2 ez His partner contributes $1,000 cash. W2 ez While each partner has increased his capital account by $1,000, which will be re