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REG CPA Practice Questions Explained: How to Calculate A Partner’s Basis In A Partnership

How to Calculate A Partner's Basis In A Partnership

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In this video, we walk through 5 REG practice questions teaching how to calculate a partner’s basis in a partnership. These questions are from REG content area 5 on the AICPA CPA exam blueprints: Federal Taxation of Entities.

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How to Calculate A Partner’s Basis In A Partnership

Calculating a partner’s basis in a partnership for tax purposes is a multi-faceted process that involves various transactions and adjustments. The partner’s basis in the partnership is important as it determines the tax implications of distributions, the ability to deduct losses, and the gain or loss on the sale of the partnership interest.

1. Initial Basis

The initial basis of a partner’s interest in a partnership is generally the amount of money and the adjusted basis of property the partner contributed to the partnership. This sets the starting point for future adjustments.

2. Adjustments to Basis

The partner’s basis in the partnership is adjusted up or down annually based on several factors:

a. Business Operations

  • Income and Gain: The partner’s basis increases with their distributive share of the partnership’s income and any gain. This includes both taxable and tax-exempt income.
  • Losses and Deductions: The partner’s basis decreases with their distributive share of the partnership’s losses and deductions, included non-deductible expenses.

b. Cash Contributions

  • Any additional contributions made by the partner during the year, whether cash or property (other than services), increase the partner’s basis.

c. Cash Distributions

  • Cash distributions reduce the partner’s basis but cannot drop it below zero. If the total distributions exceed the partner’s basis, any excess is treated as a capital gain from the sale or exchange of the partnership interest.

d. Changes in Partnership Liabilities

  • Increase in Partnership Liabilities: If the partnership takes on more debt, each partner’s basis increases by their share of this debt. This includes both recourse (where the partner is personally liable) and non-recourse liabilities (where no partner is personally liable).
  • Decrease in Partnership Liabilities: Conversely, if the partnership repays its debts or reduces its liabilities, each partner’s basis decreases by their share of this reduction. For recourse liabilities, this decrease only impacts those partners who are personally liable for the debt.

3. Special Adjustments

  • Guaranteed Payments: Payments made to a partner for services or capital that are guaranteed, regardless of the partnership’s income, do not affect the partner’s basis.
  • Disposal of Partnership Interest: Upon sale or other disposition of a partnership interest, the partner must adjust their basis to determine gain or loss. The selling price minus the adjusted basis of the partnership interest will determine the capital gain or loss.

4. Reporting and Compliance

Each partner should receive a Schedule K-1 (Form 1065) annually, which reports their share of the partnership’s income, gains, losses, deductions, and credits. This form also helps partners track changes in their basis.

Example:

Suppose a 10% partner has an initial basis of $10,000 in a partnership. During the year, they contribute an additional $5,000 in cash, the partnership earns $20,000, incurs $12,000 in losses, takes on new non-recourse liabilities of $30,000, and makes cash distributions of $4,000 to the partner. The adjustments would be:

  • Initial Basis: $10,000
  • Plus Cash Contribution: $5,000
  • Plus Income Share: $2,000 (10% of $20,000)
  • Minus Loss Share: $1,200 (10% of $12,000)
  • Plus Liability Share: $3,000 (10% of $30,000)
  • Minus Cash Distributions: $4,000

Adjusted Basis at Year End = $10,000 + $5,000 + $2,000 – $1,200 + $3,000 – $4,000 = $14,800

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