Selling Partnership Interest With Negative Capital Account In Nevada
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If any Partner has a deficit Capital Account following the liquidation of his, her or its interest in the partnership, then he, she or it shall restore the amount of such deficit balance to the Partner- ship by the end of such taxable year or, if later, within 90 days after the date of such liquida- tion, for payment ...
Per Internal Revenue Code Sections 704(a)(2) and 1367(a)(2), basis can never fall below zero. If there has been a distribution in excess of basis, then gain has to be recognized on the distribution. This gain is not reported on Schedule K-1. The partner/shareholder reports the gain on their tax return.
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).
Ordinary Loss Deduction: The loss incurred from the abandonment of partnership interest is generally deductible as an ordinary loss, which can be used to offset other ordinary income.
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.
16 Second, an owner's negative capital account may be deemed to reflect a debt to the firm that the owner must be repay to the firm.
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.
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).
