Selling Partnership Interest With Negative Capital Account In Hennepin
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FAQ
If any members of a partnership have a negative capital account, that partner is legally obligated to restore their deficit, also known as a DRO (deficit restoration obligation).
− If a partner is selling his entire partnership interest, then his share of partnership liabilities will be reduced to zero and thus his amount realized will increase by at least the entire amount of his former share of partnership liabilities.
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.
What to report: Form 1099-B reports the proceeds from the sale of the partnership interest, as well as any gains or losses. It's important to note that the broker or exchange is only required to report the gross proceeds of the sale, not the taxpayer's basis in the partnership interest.
Gain Realized Generally, a partner selling his partnership interest recognizes capital gain or loss on the sale. The amount of the gain or loss recognized is the difference between the amount realized and the partner's adjusted tax basis in his partnership interest.
A sale of a partnership interest requires two transactions: An ordinary income gain/loss reported on Form 4797, Part II, line 10. A capital gain reported on the Schedule D.
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)).
This final capital account tabulation is a great indicator of what a partner's taxable gain would be if the interest were sold. From a tax standpoint, a negative capital account is treated as a capital gain upon sale. Conversely, a positive capital account is treated as a capital loss if the interest is sold.
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).
