K-1 Tax Form Issues for Individual Taxpayers
- Partnership & S-Corp Loss Limitations
- Unreimbursed Partner Expenses
- 179 Expense Taken by Partner or S-Corporation
- Interest Expense from Debt Used to Acquire an Interest in a K-1 Activity
- Distribution from Partnership or S-Corporation
- Partner's Basis for Distributed Property
- Disposition of Activity and Passive Activity Loss
Partnership & S-Corp Loss Limitations
Partners and shareholders of S-Corporations are subject to three separate limitations on the losses and deductions reported to them on Schedule K-1. The first of these limitations is the basis limitation, which limits the losses and deductions to the adjusted basis in the activity at year-end. Any amount of loss and deduction in excess of the adjusted basis at the end of the year is disallowed in the current year and carried forward indefinitely. Next year, this carryforward is treated as having been incurred at the beginning of the year.
Once a loss or deduction is allowed by the basis limitations, it is limited to the amount the partner or shareholder has at-risk in the activity. The second limitiation, the amount at-risk, is generally the amount invested in the activity plus qualified non-recourse liabilities and, for partners, loan guarantees. The amount at-risk can be decreased by stop-loss agreements or guarantees on loans made to the entity. Similar to the basis limitation, any losses or deductions in excess of amount at-risk is disallowed and treated as being incurred in the following year.
The final limitation applied is the passive limits. Losses from a passive activity are only allowed to the extent of passive income on the return. An exception to this general rule is the special allowance for rental real estate with active participation. This special allowance allows up to $25,000 of rental real estate loss to be deducted against nonpassive income for those taxpayers with modified adjusted gross income less than $150,000. For a partner or shareholder to be eligible for the special allowance, they must own at least 10% of the capital in the partnership or S-Corporation.
Any loss not allowed in the current year is suspended and carried over indefinitely. Upon complete disposition of the activity, all passive carryovers are allowed. In the year of complete disposition, to determine the treatment of the activity, gain or loss from the disposition is combined with current-year income or loss, and prior-year unallowed loss. If the result of this is a positive number, then the activity is reported on Form 8582 so the excess passive income can free up passive losses from other activities. If the result is negative, then the activity is left off of Form 8582 and all current- and prior-year losses from the activity are allowed in full.
If the K-1 is from a publicly traded partnership, the passive limitations are applied separately to that activity. This means the losses from the publicly traded partnership are only allowed to the extent of income from that publicly traded partnership. Gains and losses from a publicly traded partnership are not reported on Form 8582; instead, a separate worksheet should be filled out showing the calculation of the passive limits for each publicly traded partnership.
Credits from a passive activity are only allowed to the extent of tax attributable to passive income (see 8582-CR form and instructions).
Unreimbursed Partner Expenses
Partners of partnerships, but not shareholders of S-Corporations, are allowed to deduct unreimbursed expenses incurred in the production of the activities income on Schedule E.
179 Expense Taken by Partner or S-Corporation
Certain assets used in the production of income are eligible to have some or all of their basis written off in the current year as a "179 expense." This 179 expense is limited to the business taxable income on the return. This taxable income limitation is applied at both the partnership and partner level. Any 179 expenses in excess of the taxable income limit are suspended and carried over to the following year, again being subjected to the taxable income limits.
When an asset that has had 179 expenses taken is disposed of by the S-Corporation or partnership, the disposition is not reported on the partnership or S-Corporation return. The information about the disposition is instead reported separately on each K-1 so the partners and shareholders can report the gain on their return. When the shareholder or partner reports the gain, they have to adjust any 179 expenses still being carried over because of the taxable income limitation.
Interest Expenses from Debt Used to Acquire an Interest in a K-1 Activity
When ownership in a K-1 activity has been purchased using debt, the interest paid on the loan has to be allocated to the activity for the purposes of applying the passive investment interest and personal interest limitations. (IRS Notice 89-35, Part IV)
The interest expense is allocated among the assets of the activity.
- If the partnership or S-Corporation activity is comprised solely of business income, then the interest expense is taken on Schedule E and identified as "Business Interest Expense."
- If the partner or shareholder does not actively participate in the activity, then the interest expense is included on Form 8582 to be subjected to the passive loss limitations.
- If any portion of the interest expense is allocated to assets that generate portfolio income (interest, dividends, etc.), then a portion of interest expense is considered investment interest expense and should be included on Form 4952, "Investment Interest Expense Deduction.
Distributions from Partnership or S-Corporation
In general, distributions from the partnership or S-Corporation are nontaxable. The distribution decreases basis, which is used in computing the Basis Limitation. If a distribution is in excess of the basis in the activity, gain must be recognized.
Partner's Basis for Distributed Property
The partner's/shareholder's basis in property distributed from the partnership/S-Corporation is the same as the basis the partnership/S-Corporation had immediately prior to the distribution. The holding period of the asset includes the partnership's/S-Corporation's holding period.
Disposition of Activity and Passive Activity Loss
When a K-1 activity has been disposed of in a taxable sale, all losses suspended in a prior year by the passive loss limitations are freed up. If the activity is sold on an installment sale, the prior-year passive losses are allowed pro rata over the life of the note. In some cases, it may be beneficial to elect out of the installment method so all prior unallowed losses are allowed in full. How the sale of the activity is reported on Form 8582 "Passive Activity Loss Limitation" depends upon whether or not the activity has an overall gain or an overall loss. Add up the current-year income/loss from the activity, suspended passive losses from the prior year, and gain/loss from disposition of the activity. If the result is an overall gain, then the activity will be reported on Form 8582 so the income is available to free up losses from other activities. If it is an overall loss, then it should not be included on Form 8582. (See Form 8582 instructions for more information.)
The allowance of losses suspended in a prior year by at-risk limits is not as clear, but proposed Regulation 1.465-66 does specify that losses suspended by at-risk may be allowed in full in the year of disposition.
There does not appear to be any provision for allowing losses suspended by the basis limitations upon disposition of the activity.