What is the order in which basis is adjusted in a partnership?
The correct answer and explanation is:
In a partnership, the order in which basis is adjusted is generally as follows:
- Initial Contributions: The basis of each partner begins with the amount of capital or property they contribute to the partnership. This initial basis is determined by the fair market value (FMV) of the property or the amount of cash contributed.
- Partnership Liabilities: If a partner assumes any partnership liabilities (such as debts), their basis is increased by the amount of the liability. This applies both to liabilities the partnership holds and to any individual partner’s share of the debt.
- Income Allocations: The basis of a partner is increased by their share of the partnership’s taxable income. The income could be in the form of profits, gains, or other items that are allocated to the partner according to the partnership agreement.
- Distributions: When a partner receives a distribution from the partnership, their basis is decreased. Distributions can be in cash or property. Cash distributions reduce the basis dollar-for-dollar, while property distributions generally reduce the basis by the property’s adjusted basis (the original cost adjusted for depreciation, improvements, etc.).
- Losses and Deductions: If the partnership incurs losses, the basis of the partner is decreased by their share of those losses. Deductions that a partner is allowed to claim (like deductions related to business expenses) also reduce the partner’s basis in the partnership.
- Partnership Liquidation or Sale: When a partner withdraws or sells their interest in the partnership, the basis is adjusted to reflect the sale or liquidation price. This involves recognizing any capital gains or losses from the transaction, which in turn impacts the partner’s remaining basis.
- Debt Payments: If a partner personally pays any debts of the partnership, their basis in the partnership is increased by the amount of the payment.
In summary, a partner’s basis in a partnership fluctuates due to contributions, income, distributions, liabilities, losses, and other adjustments. These changes are essential for calculating a partner’s share of the partnership’s income or loss, and for determining the tax consequences when the partnership interest is sold or liquidated.