Selling Partnership Interest With Negative Capital Account In Massachusetts
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FAQ
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)).
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).
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.
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.
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.
This means the ownership interest a partner has in a partnership is treated as a separate asset that can be purchased and sold.
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.
This means the ownership interest a partner has in a partnership is treated as a separate asset that can be purchased and sold.
