As per the defined regulations under section 704 b, capital accounts are expected to be maintained as per certain rules which are not part of tax or gaap. Partnerships that wish to formally comply with the substantial economic effect rules must have a provision in the partnership agreement that requires. In other words, the reporting of partner capital accounts is to use any method available in 2018such as tax basis, section 704b, gaap, or any other method. Dear sir, i like to know sch k1 partner capital accounts, if this transaction should be under under tax basis or section 704b book. Many tax professionals and investors in partnerships, llcs and other entities treated as partnerships struggle with the concepts and the operating rules that apply to section 704c. This document contains final regulations relating to the capital account maintenance rules under section 704 of the internal revenue code. Note that for tax years beginning in 2018, partnerships were required to report additional information if any partners had beginning or ending negative tax basis capital accounts. Irs provides penalty relief for failure to include. Surgents comprehensive guide to tax depreciation, expensing and property transactions july 22, 2020. Section 465a of such code as amended by this section shall not apply with respect to partnership liabilities to which the last 2 sentences of section 704d of such code as in effect on the day before the date of enactment of this act did not apply because of the provisions of section 2f2 of the tax reform act of 1976 set out as a. Partnerships need to disclose more information to irs bdo.
The increase and decrease to capital accounts of the partners for the year will not be much different than if the allocation had not been made. Allocations of tax items for inclusion on the tax return and for determining inside and outside basis are based upon tax basis and not section 704 b book value. The irs notice directs partnerships and other persons that they must include a statement identifying the method upon which a partners capital account is reported. But it can also result in complex section 704c consequences. Mar 02, 2011 change on the partners capital accounts.
Partners with a deficit balance in their capital accounts must be required, either by local law or the partnership agreement, to restore such deficit balances to the partnership upon liquidation of their interests. If a partnership reports other than tax basis capital accounts to its partners on schedule k1 in item l that is, gaap, 704b book, or other, and tax basis capital, if reported on any partners schedule k1 at the beginning or end of the tax year would be negative, the partnership must report on line 20 of schedule k1, using code ah, such. Penalty relief for capital account reporting on schedule k1. It is permissible for a partner to have a negative capital account balance, usually in tandem with an allocation of partnership debt, or. Book tax book tax cash 19,000 19,000 a capital account 9,500 9,400 100 property net book value 0 0 0 b capital account 9,500 9,600 100 initial contribution 10,000 4,000 10,000 10,000 year 1 income loss 500 0. In this manner, the partnership keeps its capital accounts consistent with an intent to provide the service partner with only a profits interest. Reporting of positive tax basis capital accounts postponed. Note that the term capital account referred to in the operating agreement means the capital accounts under irc section 704b and are referred to as the book capital accounts. Section 704b and the three ways to defend tax allocations.
May 02, 2014 background on substantial economic effect and irc section 704b may 2, 2014 in denver business attorneys, denver tax attorneys, mcguire law firm by john mcguire under internal revenue code section 704, a partnership agreement is to determine a partners distributive share of the allocated tax items, such as income, loss, gain and credits. Difference between gaap and 704 b difference between. New reporting for partner negative capital account. Jul, 2016 note that the term capital account referred to in the operating agreement means the capital accounts under irc section 704b and are referred to as the book capital accounts. Liquidating distributions must be made in accordance with those capital accounts 3. Capital accounts maintained on a section 704b book basis or on a gaap basis may differ substantially from capital accounts maintained on a tax basis. Partnership taxation in the united states wikipedia. This means that partnerships may continue to report partner capital accounts on forms 1065 or 8865, schedule k1 using any method available in 2018 tax basis, section 704 b, gaap, or any other method for 2019. One of the basic requirements of the code section 704 b capital account maintenance provisions is that partnership assets must be recorded at fair market value fmv rather than at cost basis. The partners capital accounts must be properly maintained in accordance with the accounting rules contained in the regulations 2.
This can often prove difficult when the partners are contributing assets other than cash or marketable securities to the partnership. The panel will provide you a briefing and analysis on these and other relevant topics. Difference between gaap and 704 b a knowledge archive. Other partnerships calculated their partners capital accounts using irc section 704b book basis or another hybrid basis, often related to the accounting method they followed for financial reporting purposes. Generally, capital accounts are deemed to be in accordance with regulations of section 704 b.
However, newly contributed property is reflected in the capital accounts of the partners at fair market value, rather than the contributing partners cost. Capital account challenges for partnerships and llcs. A bookup can be beneficial in order to maintain intended economics of the partnership. Prevent errors and penalties and gain a better understanding of section 704c provisions. Section 704 cintroduction if basis of contributed property differs from its section 704 b ii book value, section 704 cla requires income, gain loss, and deduction with respect to such property to be allocated among the partners 11 so as to take account of the variation between the basis of the property to the partnership and its fmv at. The instructions add that if a partnership reports capital accounts on other than the tax basis for example gaap or section 704b book basis and the partners tax basis capital accounts at the beginning or end of the year are negative, the partnership must report on line 20 of schedule k1, using code ah each such partners beginning and. Under certain circumstances, a partnership may be entitled to restate the partners capital accounts to fmv, commonly called a bookup of the partners capital accounts. Please disable popup blocking software before viewing this.
Adjustments to capital accounts for contributions and distributions are based on fair market value at the time of the event the result is a book value for section 704 b purposes for those assets. The partnership must maintain the capital accounts of the partners in order to pass the economic effects test because many of the determinations for proper allocations rely on wellmaintained capital accounts for discerning the partners interests. I understand that you adjust the inside basis of the assets, but am not sure why or how you would adjust the. The irs notice directs partnerships and other persons that they must include a statement identifying the method upon which a. However, newly contributed property is reflected in the capital accounts of the partners at fair market value, rather than.
The principals of 704c apply to property that has been revalued pursuant to 704b and have differences between book value and the adjusted tax basis that result from the revaluation. Difference between gaap and 704 b liquidation at the time of liquidation, the proceeds should be distributed among the partners in accordance with the positive capital accounts. This is a fair market value concept and should not be confused with the books as maintained by the business that may or may not be on a gaap basis. Section 704b2 pre 1976 actually required the reallocation of any separately stated item be in accordance with distributive shares of bottom line taxable income or loss. No reporting of partner tax basis capital accounts 2019.
Powerful default rules and potential tax significance donald j. Remember, as we discussed above, revaluation produces book gain or loss that impacts the capital accounts. A partners capital account reflects the partners share of the book value of the partnership and so is a better measure. These regulations expand the rules regarding a partnerships right to adjust capital accounts to reflect unrealized appreciation and depreciation in the value of partnership assets. Note that these section 704b capital account book adjustments are. Capital accounts given that the regulations focus on economic effect, a method is needed to measure a partners economic investment in the partnership. Structuring equity compensation for partnerships and llcs. If section 704 c didnt exist, a and b would split both the tax.
Please disable popup blocking software before viewing. Section 704b safe harbor capital account maintenance bookups liquidating or not liquidating with capital accounts treatment of partnership distributions differences between distributions made with regard to income and distributions made without regard to income 7. The requirements of the safe harbor are that the partnership must maintain the partners capital accounts in accordance with the sec. Compliance with section 704b of the code sample clauses. In the case of a loss which was not allowed for any taxable year by reason of the last 2 sentences of section 704d of the internal revenue code of 1986 formerly i. For instance, in a partnership business where a partner contributes a property to be part of the business, section 704 b requires that the contributing partners capital account should be credited with the propertys fair market value. Jun, 2019 under certain circumstances, a partnership may be entitled to restate the partners capital accounts to fmv, commonly called a bookup of the partners capital accounts.
In order to pass the safe haven, the partnership agreement demands that the capital accounts are maintained according to regulations of the sub chapter. If the only effect of an allocation is to reduce taxes without substantially affecting the partners pretax distributive shares, then the economic effect is not substantial. Aug 17, 2018 negative 704 b revaluations book down adjustments. Substantial economic effect background mcguire law firm. One of the basic requirements of the code section 704b capital account maintenance provisions is that partnership assets must be recorded at fair market value fmv rather than at cost basis. The prior section 704 treasury regulations held for a six factor test to determine if a specific allocation was for tax avoidance. Other partnerships calculated their partners capital accounts using irc section 704b book basis or another hybrid basis, often related to the accounting method they followed for. Section 704cintroduction if basis of contributed property differs from its section 704b ii book value, section 704cla requires income, gain loss, and deduction with respect to such property to be allocated among the partners 11 so as to take account of the variation between the basis of the property to the partnership and its fmv at. Liquidating distributions must be made in accordance with those capital accounts. Generally accepted accounting principles gaap and therefore tied to equity numbers on the books. Irs adds requirement for tax basis partner capital. And under the general rules of section 704, when a partner contributes property to a partnership, the partners capital account is equal to the value of the property, regardless of what the tax. Situations that trigger a reverse section 704c allocations how to compute the partners section 704b book capital accounts and why it matters applying a qualified income offset. Strafford capital account challenges for partnerships and llcs.
Feb 15, 2019 if a partnership reports other than tax basis capital accounts to its partners on schedule k1 in item l that is, gaap, 704 b book, or other, and tax basis capital, if reported on any partners schedule k1 at the beginning or end of the tax year would be negative, the partnership must report on line 20 of schedule k1, using code ah, such. If a partnership reports other than tax basis capital accounts i. The partnership agreement provides that book items will be allocated in accordance with the partners relative book capital accounts, that book capital accounts will be adjusted to reflect daily revaluations of property pursuant to 1. Sep 21, 2015 in some situations, a partners capital account and tax basis may start out different, and well take steps via section 704 c, or in the case of a crosspurchase, a section 754 election and. This means that partnerships may continue to report partner capital accounts on forms 1065 or 8865, schedule k1 using any method available in 2018 tax basis, section 704b, gaap, or any other method for 2019. In determining the amount of any loss under paragraph 1, there shall be taken into account the partners distributive share of amounts described in paragraphs 4 and 6 of section 702a. Allocations of tax items for inclusion on the tax return and for determining inside and outside basis are based upon tax basis and not section 704b book value. These are referred to as section 704 b capital accounts, and not tax or gaap capital accounts. Jul 23, 2014 note that these section 704 b capital account book adjustments are. Previously, partnerships could report partner capital on schedule k1 on any basis they desired, including gaap, tax basis, section 704b book and other. Making section 704c work for you practising law institute. The allocation of partnership income and loss under sec.
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