Partner's Distributive Share A partner's taxable income for a tax year includes his or herdistributive share of certain partnership items for the partnership'stax year ending with or within the partner's tax year. Gross income.When it is necessary to determine the gross income of a partner,the partner's gross income includes his or her distributive share ofthe partnership's gross income. For example, the partner's share ofthe partnership gross income is used in determining whether an incometax return must be filed by that partner. Estimated tax.Partners may have to make payments of estimated tax as a result ofpartnership income. Generally, the required estimated tax payment for individuals isthe smaller of the following amounts. 90% of the tax to be shown on the current year's taxreturn. 100% of the total tax shown on the prior year's taxreturn. A different rule applies to individuals who receive at leasttwo-thirds of their gross income from farming or fishing. See Publication 505 for more information. Self-employment income.A partner is not an employee of the partnership. The partner'sdistributive share of ordinary income from a partnership is generallyincluded in figuring net earnings from self-employment. However, alimited partner generally does not include his or her distributiveshare of income or loss in computing net earnings fromself-employment. This exclusion does not apply to guaranteed paymentsmade to a limited partner for services actually rendered to or onbehalf of a partnership engaged in a trade or business. Self-employment tax.If an individual partner has net earnings from self-employment of$400 or more for the year, the partner must figure self-employment taxon Schedule SE (Form 1040). For more information on self-employmenttax, see Publication 533. Alternative minimum tax.To figure alternative minimum tax, a partner must separately takeinto account any distributive share of items of income and deductionsthat enter into the computation of alternative minimum taxable income.For information on which items of income and deductions are affected,see the Form 6251 instructions. Figuring Distributive Share Generally, the partnership agreement determines a partner'sdistributive share of any item or class of items of income, gain,loss, deduction, or credit. The allocations provided for in thepartnership agreement or any modification will be disregarded if theydo not have substantial economic effect. If an allocation does nothave substantial economic effect or the partnership agreement does notprovide for the allocation, the partner's distributive share of thepartnership items is determined by the partner's interest in thepartnership. Substantial economic effect.An allocation has substantial economic effect if both of thefollowing tests are met. There is a reasonable possibility that the allocation willsubstantially affect the dollar amount of the partners' shares ofpartnership income or loss independently of tax consequences. The partner to whom the allocation is made actually receivesthe economic benefit or bears the economic burden corresponding tothat allocation. Partner's interest in partnership.If a partner's distributive share of a partnership item cannot bedetermined under the partnership agreement, it is determined by his orher interest in the partnership. The partner's interest is determinedby taking into account all of the following items. The partners' relative contributions to thepartnership. The interests of all partners in economic profits and losses(if different from interests in taxable income or loss) and in cashflow and other nonliquidating distributions. The rights of the partners to distributions of capital uponliquidation. Nonrecourse liability.A nonrecourse liability is one for which no partner or relatedperson has an economic risk of loss. An allocation of a loss,deduction, or partnership expense attributable to nonrecourseliabilities not deductible or chargeable to capital cannot haveeconomic effect. Therefore, a partner's share of nonrecoursedeductions is determined by his or her interest in the partnership.For the rules on allocating nonrecourse deductions, see section1.704-2 of the regulations. Reporting Distributive Share A partner must report his or her distributive share of partnershipitems on his or her tax return, whether or not it is actuallydistributed. (However, a partner's deduction for his or herdistributive share of a loss may be limited. See Limits onLosses, later.) These items are reported to the partner onSchedule K-1 (Form 1065). See the Partner's Instructions for Schedule K-1 (Form1065) for more information. The following discussions explain how partnership items are treatedon a partner's return. Character of items.The character of each item of income, gain, loss, deduction, orcredit included in a partner's distributive share is determined as ifthe partner realized the item directly from the same source as thepartnership or incurred the item in the same manner as thepartnership. For example, a partner's distributive share of gain from the saleof partnership depreciable property used in the trade or business ofthe partnership is treated as gain from the sale of depreciableproperty the partner used in a trade or business. Inconsistent treatment of items.Partners must generally treat partnership items the same way ontheir individual tax returns as they are treated on the partnershipreturn. If a partner treats an item differently on his or herindividual return, the IRS can immediately assess and collect any taxand penalties that result from adjusting the item to make itconsistent with the partnership return. However, this rule will notapply if a partner identifies the different treatment by filingForm 8082, Notice of Inconsistent Treatment orAdministrative Adjustment Request (AAR), with his or her return. Consolidated audit procedures.Under current examination procedures, the tax treatment of anypartnership item is generally determined at the partnership level in aconsolidated audit proceeding, rather than at the individual partner'slevel. After the proper treatment is determined at the partnershiplevel, the IRS can automatically make related adjustments to the taxreturns of the partners, based on their share of the adjusted items. The consolidated audit procedures do not apply to certain smallpartnerships (with 10 or fewer partners) if all partners are one ofthe following. An individual (other than a nonresident alien). A C corporation. An estate of a deceased partner. However, small partnerships can make an election to have theseprocedures apply. Caution: For partnership tax years ending before August 6, 1997, theseprocedures do not apply to small partnerships if both of the followingapplied. All partners were individuals (other than nonresidentaliens) or estates. The partnership did not make a special allocation of anypartnership item. Limits on Losses Partner's adjusted basis.A partner's distributive share of partnership loss is allowed onlyto the extent of the adjusted basis of the partner's partnershipinterest. The adjusted basis is figured at the end of thepartnership's tax year in which the loss occurred, before taking theloss into account. Any loss more than the partner's adjusted basis isnot deductible for that year. However, any loss not allowed for thisreason will be allowed as a deduction (up to the partner's basis) atthe end of any succeeding year in which the partner increases his orher basis to more than zero. See Basis of Partner's Interest,later. Example.Mike and Joe are equal partners in a partnership. Mike files hisindividual return on a calendar year basis. The partnership return isalso filed on a calendar year basis. The partnership incurred a$10,000 loss last year and Mike's distributive share of the loss is$5,000. The adjusted basis of his partnership interest beforeconsidering his share of last year's loss was $2,000. He could claimonly $2,000 of the loss on last year's individual return. The adjustedbasis of his interest at the end of last year was then reduced tozero. The partnership showed an $8,000 profit for this year. Mike's$4,000 share of the profit increased the adjusted basis of hisinterest by $4,000 (not taking into account the $3,000 excess loss hecould not deduct last year). His return for this year will show his$4,000 distributive share of this year's profits and the $3,000 lossnot allowable last year. The adjusted basis of his partnershipinterest at the end of this year is $1,000. Not-for-profit activity.hotel a RigaDeductions relating to an activity not engaged in for profit arelimited. For a discussion of the limits, see chapter 1 in Publication 535. At-risk limits.At-risk rules apply to most trade or business activities, includingactivities conducted through a partnership. The at-risk rules limit apartner's deductible loss to the amounts for which that partner isconsidered at risk in the activity. A partner is considered at risk for all of the following amounts. The money and adjusted basis of any property he or shecontributed to the activity. The partner's share of net income retained by thepartnership. Certain amounts borrowed by the partnership for use in theactivity if the partner is personally liable for repayment or theamounts borrowed are secured by the partner's property (other thanproperty used in the activity). A partner is not considered at risk for amounts protected againstloss through guarantees, stop-loss agreements, or similararrangements. Nor is the partner at risk for amounts borrowed if thelender has an interest in the activity (other than as a creditor) oris related to a person (other than the partner) having such aninterest. For more information on determining the amount at risk, seePublication 925. Passive activities.luxury hotels in EstorilGenerally, section 469 of the Internal Revenue Code limits theamount a partner can deduct for passive activity losses and credits.The passive activity limits do not apply to the partnership. Instead,they apply to each partner's share of income, loss, or credit frompassive activities. Because the treatment of each partner's share ofpartnership income, loss, or credit depends on the nature of theactivity that generated it, the partnership must report income, loss,and credits separately for each activity. Generally, passive activities include a trade or business activityin which the partner does not materially participate. The level ofeach partner's participation must be determined by the partner. Rental activities.Passive activities also include rental activities, regardless ofthe partner's participation. However, a rental real estate activity inwhich the partner materially participates is not considered a passiveactivity. The partner must also meet both of the following conditionsfor the tax year. More than half of the personal services the partner performsin any trade or business are in a real property trade or business inwhich the partner materially participates. The partner performs more than 750 hours of services in realproperty trades or businesses in which the partner materiallyparticipates. Limited partners.Limited partners are generally not considered to materiallyparticipate in trade or business activities conducted throughpartnerships. More information.For more information on passive activities, see Publication 925 andthe instructions for Forms 1065 and 8582. Partner's Exclusions and Deductions To determine the allowable amount of any exclusion or deductionsubject to a limit, a partner must combine any separate exclusions ordeductions on his or her income tax return with the distributive shareof partnership exclusions or deductions before applying the limit. Cancellation of qualified real property business debt.A partner other than a C corporation can elect to exclude fromgross income the partner's distributive share of income fromcancellation of the partnership's qualified real property businessdebt. This is a debt (other than a qualified farm debt) incurred orassumed by the partnership in connection with real property used inits trade or business and secured by that property. A debt incurred orassumed after 1992 qualifies only if it was incurred or assumed toacquire, construct, reconstruct, or substantially improve suchproperty. A debt incurred to refinance a qualified real propertybusiness debt qualifies, but only up to the refinanced debt. A partner who elects the exclusion must reduce the basis of his orher depreciable real property by the amount excluded. For thispurpose, a partnership interest is treated as depreciable realproperty to the extent of the partner's share of the partnership'sdepreciable real property. However, a partnership interest cannot betreated as depreciable real property unless the partnership makes acorresponding reduction in the basis of its depreciable real propertywith respect to that partner. To elect the exclusion, the partner mustfile Form 982, Reduction of Tax Attributes Due ToDischarge of Indebtedness, with his or her original income taxreturn. However, if the partner timely filed the return without makingthe election, he or she can still make the election by filing anamended return within six months of the due date of the originalreturn (excluding extensions). The election must be attached to theamended return with "Filed pursuant to section 301.9100-2"written on the election statement. The amended return should be filedat the same address as the original return. Exclusion limit.The partner's exclusion cannot be more than the smaller of thefollowing two amounts. The partner's share of the excess (if any) of: The outstanding principal of the debt immediately before thecancellation, over The fair market value (as of that time) of the propertysecuring the debt, reduced by the outstanding principal of otherqualified real property business debt secured by that property (as ofthat time). The total adjusted bases of depreciable real property heldby the partner immediately before the cancellation (other thanproperty acquired in contemplation of the cancellation). Effect on partner's basis.Because of offsetting adjustments, the cancellation of apartnership debt does not usually cause a net change in the basis of apartnership interest. Each partner's basis is: Increased by his or her share of the partnership income fromthe cancellation of debt (whether or not the partner excludes theincome), and Reduced by the deemed distribution resulting from thereduction in his or her share of partnership liabilities. (See Adjusted Basis under Basis of Partner'sInterest, later.) The basis of a partner's interest will changeonly if the partner's share of income is different from the partner'sshare of debt. As explained earlier, however, a partner's election to excludeincome from the cancellation of qualified real property business debtmay reduce the basis of the partner's interest to the extent theinterest is treated as depreciable real property. Basis of depreciable real property reduced.If the basis of depreciable real property is reduced and theproperty is disposed of, then the following rules apply for purposesof determining the ordinary income from recapture of depreciationunder section 1250 of the Internal Revenue Code. Any such basis reduction is treated as a deduction allowedfor depreciation. The determination of what would have been the depreciationadjustment under the straight line method is made as if there had beenno such reduction. Therefore, the basis reduction recaptured as ordinary income isreduced over the time the partnership continues to hold the property,as the partnership forgoes depreciation deductions due to the basisreduction. Section 179 deduction.A partner can elect to deduct all or part of the cost of certainassets under section 179 of the Internal Revenue Code. Limits.The section 179 deduction is subject to certain limits that applyto the partnership and to each partner. The partnership determines itssection 179 deduction subject to the limits. It then allocates thededuction among its partners. Each partner adds the amount allocated from the partnership (shownon Schedule K-1) to his or her other nonpartnership section 179costs and then applies the maximum dollar limit to this total. Todetermine if a partner has exceeded the $200,000 investment limit, thepartner does not include any of the cost of section 179 propertyplaced in service by the partnership. After the maximum dollar limitand investment limit are applied, the remaining cost of thepartnership and nonpartnership section 179 property is subject to thetaxable income limit. Figuring partnership's taxable income.For purposes of the taxable income limit, taxable income of apartnership is figured by adding together the net income (or loss)from all trades or businesses actively conducted by the partnershipduring the tax year. Figuring partner's taxable income.For purposes of the taxable income limit, the taxable income of apartner who is engaged in the active conduct of one or more of apartnership's trades or businesses includes his or her allocable shareof taxable income derived from the partnership's active conduct of anytrade or business. Basis adjustment.A partner who is allocated section 179 expenses from thepartnership must reduce the basis of his or her partnership interestby the total section 179 expenses allocated, regardless of whether thefull amount allocated can be currently deducted. See AdjustedBasis under Basis of Partner's Interest, later. If apartner disposes of his or her interest in a partnership, thepartner's basis for determining gain or loss is increased by anyoutstanding carryover of disallowed deductions of section 179 expensesallocated from the partnership. The basis of a partnership's section 179 property must be reducedby the section 179 deduction elected by the partnership. Thisreduction of basis must be made even if any partner cannot deduct hisor her entire allocable share of the section 179 deduction because ofthe limits. More information.See Publication 946 for more information on the section 179deduction. Helsingborg Hotele en promocionPartnership expenses paid by partner.In general, a partner cannot deduct partnership expenses paid outof personal funds unless the partnership agreement requires thepartner to pay the expenses. These expenses are usually consideredincurred and deductible by the partnership. If an employee of the partnership performs part of a partner'sduties and the partnership agreement requires the partner to pay theemployee out of personal funds, the partner can deduct the payment asa business expense. Interest expense for distributed loan.If the partnership distributes borrowed funds to a partner, thepartnership should list the partner's share of interest expense forthese funds as "Interest expense allocated to debt-financeddistributions" under "Other deductions" on the partner'sSchedule K-1. The partner deducts this interest on his or hertax return depending on how the partner uses the funds. See chapter 8in Publication 535 for more information on the allocation of interestexpense related to debt-financed distributions. Debt-financed acquisitions.The interest expense on loan proceeds used to purchase an interestin, or make a contribution to, a partnership must be allocated asexplained in chapter 8 of Publication 535. Distributive Share in Yearof Disposition If a partner's entire interest in a partnership is disposed of,whether by sale, exchange, liquidation, the partner's death, orotherwise, his or her distributive share of partnership items must beincluded in the partner's income for the tax year in which membershipin the partnership ends. To compute the distributive share of theseitems, the partnership's tax year is considered ended on the date thepartner disposed of the interest. To avoid an interim closing of thepartnership books, the partners can agree to estimate the distributiveshare by taking the prorated amount the partner would have included inincome if he or she had remained a partner for the entire partnershiptax year. A partner who sells or exchanges only part of an interest in apartnership, or whose interest is reduced (whether by entry of a newpartner, partial liquidation of a partner's interest, gift, orotherwise), reports his or her distributive share of partnership itemsby taking into account his or her varying interests during thepartnership year. Example.ABC is a calendar year partnership with three partners, Alan, Bob,and Cathy. Under the partnership agreement, profits and losses areshared in proportion to each partner's contributions. On January 1 theratio was 90% for Alan, 5% for Bob, and 5% for Cathy. On December 1Bob and Cathy each contributed additional amounts. The new profit andloss sharing ratios were 30% for Alan, 35% for Bob, and 35% for Cathy.For its tax year ended December 31, the partnership had a loss of$1,200. This loss occurred equally over the partnership's tax year.The loss is divided among the partners as follows: Profit Part or Loss of Year Total Share Partner % Held Loss = of Loss Alan 90 11/12 $1,200 = $990 30 1/12 1,200 = 30 Bob 5 11/12 1,200 = 55 35 1/12 1,200 = 35 Cathy 5 11/12 1,200 = 55 35 1/12 1,200 = 35 Certain cash basis items prorated daily.If any partner's interest in a partnership changes during the taxyear, each partner's share of certain cash basis items of thepartnership must be determined by prorating the items on a dailybasis. That daily portion is then allocated to the partners inproportion to their interests in the partnership at the close of eachday. This rule applies to the following items for which thepartnership uses the cash method of accounting. Interest. Taxes. Payments for services or for the use of property. Self-employment income of deceased partner.A different rule applies in computing a deceased partner'sself-employment income for the year of death. The partner'sself-employment income includes the partner's distributive share ofincome earned by the partnership through the end of the month in whichthe partner's death occurs. This is true even though the deceasedpartner's estate or heirs may succeed to the decedent's rights in thepartnership. For this purpose, partnership income for the year inwhich a partner dies is considered to be earned equally in each month. Example.Larry, a partner in WoodsPar, is a calendar year taxpayer.WoodsPar's fiscal year ends June 30. For the partnership year endingJune 30, 1999, Larry's distributive share of partnership profits is$2,000. On August 18, 1999, Larry dies and his estate succeeds to hispartnership interest. For the partnership year ending June 30, 2000,Larry and his estate's distributive share is $3,000. Larry's self-employment income to be reported on Schedule SE (Form1040) for 1999 is $2,500. This consists of his $2,000 distributiveshare for the partnership tax year ending June 30, 1999, plus $500 ( 2/12 $3,000) of the distributive share for the taxyear ending June 30, 2000.