In the last few days we have provided an overview of what a Form K-1 does, reviewed why your basis in your partnership or S corporation investment is important, and discussed how the at-risk rules can limit your K-1 losses. Today we will go through two simple examples on how K-1 items can go on your return.
EXAMPLE 1. Hillary and Barack decide to buy the White House Apartments together in a partnership, Hope LLC. They each contribute $50,000 in cash. The partnership uses the $100,000 cash and a $900,000 bank loan (8%, interest only) to buy the building. The get $72,000 in rent income, exactly offsetting the interest expense. There are no other expenses. Depreciation on the building is $34,848, which turns out to be the net loss for the year. The two 50% partners decide rental policy and approve tenants together, but they are not full-time real estate professionals.
They will receive a partnership Form 1065 K-1 with a loss on Part III, line 2.:
Lets look at Part II of their K-1 to see whether they have any at-risk basis for their loss:
They have each $50,000 basis from their cash contributions. Their basis also includes $450,000 each of debt. The debt is "qualified non-recourse" debt, so it is considered "at-risk." That means the partners have $500,000 of at-risk basis, which is plenty for a $17,424 loss. They will carry this loss to Worksheet 1 on their Form 8582, the passive loss form, to determine whether they have a deductible loss.
EXAMPLE 2: Instead of buying an apartment building, Hillary and Barack buy a $1 million piece of equipment in Hope LLC. They each contribute $50,000 in cash to the partnership. The partnership borrows $900,000 to buy the equipment, and the friendly finance company doesn't get personal guarantees on the debt. If they can't make the payments, the partners only lose their capital contributions and the finance company repossesses the equipment.
Hope LLC's leases the equipment out. Their rental income is exactly the same as the partnership's interest expense. The equipment is depreciated over five years, so the depreciation deduction is $200,000; that is also the taxable loss for the partnership for the year. Part III, Line 3 of each K-1 reports each partner's $100,000 share of the loss:
Do the partners have enough at-risk basis to deduct the loss?
They are "at-risk" for their $50,000 cash contributions. While they also have basis for their $450,000 share of debt, the debt is "nonrecourse," so they are not "at-risk" for it. They will go to Form 6198 to determine how much of their loss is allowed under the at-risk rules. In this case, it will be $50,000; the $50,000 loss for which they are not at-risk carries forward to next year. The $50,000 at-risk loss will carry to Worksheet 3 of Form 8582, where it will run the gauntlet of the passive loss rules.
I hope this thrilling series on reading your K-1 helps you understand how a K-1 works. Still, you have to ask yourself: is it a good idea for you do perform these computations on your own? If you have a pretty good legal or accounting background, maybe. If you aren't sure you understand it, though, you should talk to a tax pro. No less an authority than Dr. Maule says this stuff is hard.
This is another installment of our daily series of 2008 filing season tax tips.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to