Chapter 10
Partnership Taxation
Income Tax Fundamentals 2010
Gerald E. Whittenburg
Martha Altus-Buller
Student’s Copy
2010 Cengage Learning
1

A partnership is a syndicate, group, pool,
joint venture or other unincorporated
organization through which any business,
financial operation or venture is carried on
◦ Simply co-owning property does not constitute a
partnership
 Note: many co-owners of real estate choose to
operate as a limited partnership or limited liability
company
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When forming a partnership, individuals
contribute assets to partnership in exchange
for a partnership interest
 No gain/loss is usually recognized
 Exceptions include

◦ When services are performed in exchange for
partnership interest
◦ When property is contributed with liabilities in excess
of basis, then
Recognized Gain = Liabilities Allocable to Others –
Adjusted Basis of Property Contributed
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
Partner’s basis in partnership interest
plus:
plus:
less:
Equals:
Cash contributed
Basis of property transferred to partnership
Gain recognized (from prior screen)
Liabilities allocable to other partners
Partner’s initial basis in partnership
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Changes occur to partner’s basis due to subsequent activities
Beginning Basis
+
Additional Contributions
+
Share of Net Ordinary Taxable Income
+
Share of Capital Gains/Other Income
Distributions of Property or $
Share of Net Loss from Operations*
Share of Capital Losses/Other Deductions
+/Increase/Decrease in Liabilities
Basis in Partnership Interest
*Note: Can’t take basis below 0 and must comply with at-risk limitations
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
Partnerships do not pay tax
◦ All information flows through to be reported by the partners
◦ Tax return is due by 15th of 4th month following close of
partnership tax year

Must report each element of income and expense
separately on Form 1065 (Partnership Tax Return)
◦ Schedule K-1 shows allocable partnership
income/expenses for each partner based upon the
individual ownership percentage
 Ordinary income/loss
 Special income/deduction items such as charitable deductions,
interest, capital gains/losses
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
Partners cannot deduct losses from activities in
excess of their investment
° Losses limited to amounts at risk (AAR) in those activities

Definitions
◦ A “nonrecourse liability” is a debt for which the borrower is
not personally liable
◦ “Encumbered property” is the property pledged for a liability

Taxpayers are at-risk for an amount equal to
Cash and property contributed to partnership
+ Liabilities on encumbered properties (recourse debt)
+ Liabilities for which taxpayer is personally liable
(recourse debt)
+ Retained profits in activity
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
Limited Liability Companies (LLCs) are a cross
between a partnership and a corporation
◦ Treated generally as a partnership for tax purposes
◦ Each owner has limited liability (similar to a corporation)

Advantages of LLCs are numerous
◦
◦
◦
◦
◦
◦
◦
Taxable income/loss passes through to owners
No general partner requirement
Owners can participate in management
Owners have limited liability
LLC ownership interest is not a security
Tax attributes pass through to owners
Offer greater tax flexibility than S corporations
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
Disadvantages
◦ Because of newness, limited amount of case law
dealing with limited liability companies
◦ States are not uniform in treatment of LLCs, so
potential for confusion if LLC operating in more than
one state
Note: Limited Liability Companies quickly becoming a
major form of business organization in the U.S.
2010 Cengage Learning