Selling Partnership Interest With Negative Capital Account In Chicago
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A Deficit Restoration Obligation is an obligation by a partner in a partnership (or a member in an LLC taxed as a partnership) to restore the negative balance in its capital account when the partnership liquidates.
Losses suspended under the at-risk rules may become deductible in a year in which a partner does not have tax basis in his partnership interest. The deduction of the suspended losses in a subsequent year reduces the amount the taxpayer is at risk (Sec. 465(b)(5)).
A DRO requires a partner to restore any negative balance (deficit) in their capital account upon the liquidation of the partnership. The DRO demonstrates the partner's willingness to assume the economic risk of loss in the partnership.
The partner with a deficit contributes enough assets to offset the deficit balance. The deficit balance is removed from the accounting records with only the remaining partners sharing in future gains and losses. The other partners file a legal suit against the partner with the deficit balance.
But if his capital account is negative, all additional partnership losses are disallowed. He will need to keep track of his disallowed losses because he can use them to offset future income (once his capital account is positive again).
This means the ownership interest a partner has in a partnership is treated as a separate asset that can be purchased and sold.
A partner's capital account can't begin with a negative balance. However, a partner can have a negative capital account after accounting for the partner's distributive share of losses and distributions. A partner's outside basis should never have a negative balance.
