Discussion:Negative capital accounts
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| Yes, if there is a decrease in partnership minimum gain, each partner must be allocated a share of the minimum gain charge-back. However, the minimum gain charge-back rules would not apply if all of the debt was full-recourse. | Yes, if there is a decrease in partnership minimum gain, each partner must be allocated a share of the minimum gain charge-back. However, the minimum gain charge-back rules would not apply if all of the debt was full-recourse. | ||
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| + | {{ForumReplyPost|UserID=Riley2|Date=6 September 2009|Text=Also, if the debt was full-recourse, not really sure that losses should have been allocated to the noncontributing partners unless there was a deficit restoration requirement in the partnership agreement.}} | ||
Revision as of 06:27, 6 September 2009
Discussion Forum Index --> Advanced Tax Questions --> Negative capital accounts
Discussion Forum Index --> Tax Questions --> Negative capital accounts
Lakemartin (talk|edits) said: | 3 September 2009 |
| I have a real estate partnership client. Apartments. One equity investor put in about 7 mil. Two other partners put in zero. Using debt basis the two who put in zero now have negative capital accounts caused by rental losses. The partnership sells the apartments for a 4mil loss. In the same year has rental loss of 1.5mil. The partnership still has a little cash, a few payables and has not been terminated. According to the minimum gain chargeback provision, it appears that the partners must recognize income to bring their capital accounts into line with their allocated share of what little debt remains. The real estate was sold at a loss. The rental activity was a loss. Where do I get the income to allocate to the partners with negative capital accounts? If they took rental losses, do I show rental income? I guess I am confused about the character of the income and how is this done on the K-1's? HELP! | |
| 3 September 2009 | |
| Was partnership's "trade or busineess", apartment rentals? Usually apartment rentals (I assume condo's) are not a trade or business. What is the debt basis? Loans to the partnership, or mortgages on the apartments? I don't know what minimum gain chargeback provision is. | |
| 4 September 2009 | |
| Lakemartin what happened to the debt? Since you say basis was provided by debt,doesn't the partnership have Cancellation of Debt income, if it was operating at a loss? | |
Lakemartin (talk|edits) said: | 4 September 2009 |
| Trade was apartment rentals. Actually condo development train wreck turned into apartments and rented. Roughly 34mil in assets, 27.5mil mortgage loan and 7 mil of equity. No forgiveness of debt. Bank recovered the principal and forgave some interest and penalty accruals. This resulted in reduction of interest expense and some reduction in basis for the interest accrued during the construction period still unpaid. The equity partner just took a major haircut. Hopefully this answers your questions. | |
| 4 September 2009 | |
| If the partneship had $34 million in assets and $27.5 in mortgage, there was no minimum gain, therefore, I am not sure how the debt was originally allocated to the partners who now have negative capital accounts. Under 752, nonrecourse debt is first allocated to the extent there is a minimum gain which I do not see here unless I am overlooking something. | |
Lakemartin (talk|edits) said: | 4 September 2009 |
| I'm still lost. You're surprised, I know. Are you saying that these partners should not have been allocated the losses in prior years according to the P&L allocation percentages in the partnership agreement? | |
| 4 September 2009 | |
| Not having all the details, it appears that the loss allocation in prior years might not have been correct. I must say I have some familiarty with 704(b) but I ain't no 704(b)expert. | |
| 5 September 2009 | |
| Lake, it's not a partnership issue ... it is a partner issue.
It appears that you have allocated the rental loss and sale loss among the partners ... and as a result, some partners now have negative capital balances. (Note: Were your allocations in accordance with the operating agreement? .... I hope so.) It sounds like you have read tax literature, that you don't seem to understand, regarding negative capital balances. You have been greatly misinformed if you think that the partnership has to do something to force the negative capital balances to $-0-. You should leave the negative capital balances alone. Do not pull some magical income $amount out of the air to use as an off-set to bring the deficit capital accounts to a $-0- position. It's not expected of you and it's nonsense to even consider. The individual partner's will have to deal with the negative capital balances when they prepare their 1040. A partner who's K-1 shows a negative capital balnce will have to limit his deductible pass-through K-1 loss to his adjusted basis in the partnership. Any loss not deducted, by the partner, due to basis limitation ... will be suspended until the partner has future basis against which to deduct it. So- you, as the preparer of the partnership return should not worry about what to do. You should do nothing. The responability of dealing with negative partnership balances is a partner respnsability and will be dealth with by each parter seperately when he/she prepares his/her 1040. | |
| 5 September 2009 | |
| In order for the partnership allocation to be respected,allocation must have substantial economic effect (SEE) under 704(b). Three tests must be met for the allocation to have substantial effect; a)Maintenance of proper capital account b)Liquidating distribution must be in accordance with the capital account and c)There should be a negative restoration provision in the partnership agreement to compel partners with negative capital account to contribute to the partnership to bring their negative accounts to zero. Now if an agreement meets the first two requirements, but not the third requirement (i.e. the negative capital restoration), the partnership agreement can still meet the SEE requirements if it has a provision which will not permit loss allocation to cause or increase a deficit balance in the partners' captial account.Therefore,if the partnership does not observe the 704(b) rules of SEE, the partnership will end up having partners with erroneus negative captial accounts.
The other scenario when a partner can end up with an erroneous negative captial account is when the partnership does not follow Section 752 nonrecouse debt allocation (i.e. not taking the minimum gain rule)and allocates losses to a partner. Both of the above cases (sections 704(b) and 752)are partnership issues, so I respectfully disagree with Derwood opinion. | |
| 5 September 2009 | |
| AmirK, Sec 704(b) only deals with special allocations. If there are no special allocations then 704(b) is ignored.
Sec 752 and nonrecourse debt does not affect capital balances. Sec 752 and nonrecourse only affects partner's outide cost basis. | |
Laketahoecpa (talk|edits) said: | 5 September 2009 |
| Its been quite awhile since I've had to deal with 704(b) issues but I believe AmirK explained it very well.
I disagree that 704(b) only deals with special allocations. The application of 704(b) may cause allocations of partnership losses to the partners that is different from their ownership percentages - but that's the whole point - to make sure the allocation meets the requirement of Substantial Econcomic Effect. | |
| 6 September 2009 | |
| Lake, a few hours ago you asked where you should get income to allocate to partners with negative capital balances (the most absurd question I've ever heard). Now you suddenly have knowledge about 704(b). Are you for real ...?
The economic effect requirements of 704(b) only deal with special allocations. Since non-special allocations are based strictly on partners profit & loss sharing ratios, then non-special allocations are automatically respected for tax purposes and therefore do not have to satisfy the economic effect requirements of 704(b) in order to be respected for tax purposes. | |
| 6 September 2009 | |
| The substantial economic effect rule applies even when there are no special allocations.
Yes, if there is a decrease in partnership minimum gain, each partner must be allocated a share of the minimum gain charge-back. However, the minimum gain charge-back rules would not apply if all of the debt was full-recourse. | |
| 6 September 2009 | |
| Also, if the debt was full-recourse, not really sure that losses should have been allocated to the noncontributing partners unless there was a deficit restoration requirement in the partnership agreement. | |
