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File State Return Only

File state return only 3. File state return only   Ordinary or Capital Gain or Loss for Business Property Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Section 1231 Gains and LossesNonrecaptured section 1231 losses. File state return only Depreciation RecaptureSection 1245 Property Section 1250 Property Installment Sales Gifts Transfers at Death Like-Kind Exchanges and Involuntary Conversions Multiple Properties Introduction When you dispose of business property, your taxable gain or loss is usually a section 1231 gain or loss. File state return only Its treatment as ordinary or capital is determined under rules for section 1231 transactions. File state return only When you dispose of depreciable property (section 1245 property or section 1250 property) at a gain, you may have to recognize all or part of the gain as ordinary income under the depreciation recapture rules. File state return only Any remaining gain is a section 1231 gain. File state return only Topics - This chapter discusses: Section 1231 gains and losses Depreciation recapture Useful Items - You may want to see: Publication 534 Depreciating Property Placed in Service Before 1987 537 Installment Sales 547 Casualties, Disasters and Thefts 551 Basis of Assets 946 How To Depreciate Property Form (and Instructions) 4797 Sales of Business Property See chapter 5 for information about getting publications and forms. File state return only Section 1231 Gains and Losses Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions (discussed below). File state return only Their treatment as ordinary or capital depends on whether you have a net gain or a net loss from all your section 1231 transactions. File state return only If you have a gain from a section 1231 transaction, first determine whether any of the gain is ordinary income under the depreciation recapture rules (explained later). File state return only Do not take that gain into account as section 1231 gain. File state return only Section 1231 transactions. File state return only   The following transactions result in gain or loss subject to section 1231 treatment. File state return only Sales or exchanges of real property or depreciable personal property. File state return only This property must be used in a trade or business and held longer than 1 year. File state return only Generally, property held for the production of rents or royalties is considered to be used in a trade or business. File state return only Depreciable personal property includes amortizable section 197 intangibles (described in chapter 2 under Other Dispositions). File state return only Sales or exchanges of leaseholds. File state return only The leasehold must be used in a trade or business and held longer than 1 year. File state return only Sales or exchanges of cattle and horses. File state return only The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 2 years or longer. File state return only Sales or exchanges of other livestock. File state return only This livestock does not include poultry. File state return only It must be held for draft, breeding, dairy, or sporting purposes and held for 1 year or longer. File state return only Sales or exchanges of unharvested crops. File state return only The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person and the land must be held longer than 1 year. File state return only You cannot keep any right or option to directly or indirectly reacquire the land (other than a right customarily incident to a mortgage or other security transaction). File state return only Growing crops sold with a lease on the land, though sold to the same person in the same transaction, are not included. File state return only Cutting of timber or disposal of timber, coal, or iron ore. File state return only The cutting or disposal must be treated as a sale, as described in chapter 2 under Timber and Coal and Iron Ore. File state return only Condemnations. File state return only The condemned property must have been held longer than 1 year. File state return only It must be business property or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. File state return only It cannot be property held for personal use. File state return only Casualties and thefts. File state return only The casualty or theft must have affected business property, property held for the production of rents and royalties, or investment property (such as notes and bonds). File state return only You must have held the property longer than 1 year. File state return only However, if your casualty or theft losses are more than your casualty or theft gains, neither the gains nor the losses are taken into account in the section 1231 computation. File state return only For more information on casualties and thefts, see Publication 547. File state return only Property for sale to customers. File state return only   A sale, exchange, or involuntary conversion of property held mainly for sale to customers is not a section 1231 transaction. File state return only If you will get back all, or nearly all, of your investment in the property by selling it rather than by using it up in your business, it is property held mainly for sale to customers. File state return only Example. File state return only You manufacture and sell steel cable, which you deliver on returnable reels that are depreciable property. File state return only Customers make deposits on the reels, which you refund if the reels are returned within a year. File state return only If they are not returned, you keep each deposit as the agreed-upon sales price. File state return only Most reels are returned within the 1-year period. File state return only You keep adequate records showing depreciation and other charges to the capitalized cost of the reels. File state return only Under these conditions, the reels are not property held for sale to customers in the ordinary course of your business. File state return only Any gain or loss resulting from their not being returned may be capital or ordinary, depending on your section 1231 transactions. File state return only Copyrights. File state return only    The sale of a copyright, a literary, musical, or artistic composition, or similar property is not a section 1231 transaction if your personal efforts created the property, or if you acquired the property in a way that entitled you to the basis of the previous owner whose personal efforts created it (for example, if you receive the property as a gift). File state return only The sale of such property results in ordinary income and generally is reported in Part II of Form 4797. File state return only Treatment as ordinary or capital. File state return only   To determine the treatment of section 1231 gains and losses, combine all your section 1231 gains and losses for the year. File state return only If you have a net section 1231 loss, it is ordinary loss. File state return only If you have a net section 1231 gain, it is ordinary income up to the amount of your nonrecaptured section 1231 losses from previous years. File state return only The rest, if any, is long-term capital gain. File state return only Nonrecaptured section 1231 losses. File state return only   Your nonrecaptured section 1231 losses are your net section 1231 losses for the previous 5 years that have not been applied against a net section 1231 gain. File state return only Therefore, if in any of your five preceding tax years you had section 1231 losses, a net gain for the current year from the sale of section 1231 assets is ordinary gain to the extent of your prior losses. File state return only These losses are applied against your net section 1231 gain beginning with the earliest loss in the 5-year period. File state return only Example. File state return only In 2013, Ben has a $2,000 net section 1231 gain. File state return only To figure how much he has to report as ordinary income and long-term capital gain, he must first determine his section 1231 gains and losses from the previous 5-year period. File state return only From 2008 through 2012 he had the following section 1231 gains and losses. File state return only Year Amount 2008 -0- 2009 -0- 2010 ($2,500) 2011 -0- 2012 $1,800 Ben uses this information to figure how to report his net section 1231 gain for 2013 as shown below. File state return only 1) Net section 1231 gain (2013) $2,000 2) Net section 1231 loss (2010) ($2,500)   3) Net section 1231 gain (2012) 1,800   4) Remaining net section 1231 loss from prior 5 years ($700)   5) Gain treated as  ordinary income $700 6) Gain treated as long-term  capital gain $1,300 Depreciation Recapture If you dispose of depreciable or amortizable property at a gain, you may have to treat all or part of the gain (even if otherwise nontaxable) as ordinary income. File state return only To figure any gain that must be reported as ordinary income, you must keep permanent records of the facts necessary to figure the depreciation or amortization allowed or allowable on your property. File state return only This includes the date and manner of acquisition, cost or other basis, depreciation or amortization, and all other adjustments that affect basis. File state return only On property you acquired in a nontaxable exchange or as a gift, your records also must indicate the following information. File state return only Whether the adjusted basis was figured using depreciation or amortization you claimed on other property. File state return only Whether the adjusted basis was figured using depreciation or amortization another person claimed. File state return only Corporate distributions. File state return only   For information on property distributed by corporations, see Distributions to Shareholders in Publication 542, Corporations. File state return only General asset accounts. File state return only   Different rules apply to dispositions of property you depreciated using a general asset account. File state return only For information on these rules, see Publication 946. File state return only Section 1245 Property A gain on the disposition of section 1245 property is treated as ordinary income to the extent of depreciation allowed or allowable on the property. File state return only See Gain Treated as Ordinary Income, later. File state return only Any gain recognized that is more than the part that is ordinary income from depreciation is a section 1231 gain. File state return only See Treatment as ordinary or capital under Section 1231 Gains and Losses, earlier. File state return only Section 1245 property defined. File state return only   Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and that is any of the following types of property. File state return only Personal property (either tangible or intangible). File state return only Other tangible property (except buildings and their structural components) used as any of the following. File state return only See Buildings and structural components below. File state return only An integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services. File state return only A research facility in any of the activities in (a). File state return only A facility in any of the activities in (a) for the bulk storage of fungible commodities (discussed on the next page). File state return only That part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following. File state return only Amortization of certified pollution control facilities. File state return only The section 179 expense deduction. File state return only Deduction for clean-fuel vehicles and certain refueling property. File state return only Deduction for capital costs incurred in complying with Environmental Protection Agency sulfur regulations. File state return only Deduction for certain qualified refinery property. File state return only Deduction for qualified energy efficient commercial building property. File state return only Amortization of railroad grading and tunnel bores, if in effect before the repeal by the Revenue Reconciliation Act of 1990. File state return only (Repealed by Public Law 99-514, Tax Reform Act of 1986, section 242(a). File state return only ) Certain expenditures for child care facilities if in effect before repeal by Public Law 101-58, Omnibus Budget Reconciliation Act of 1990, section 11801(a)(13) (except with regards to deductions made prior to November 5, 1990). File state return only Expenditures to remove architectural and transportation barriers to the handicapped and elderly. File state return only Deduction for qualified tertiary injectant expenses. File state return only Certain reforestation expenditures. File state return only Deduction for election to expense qualified advanced mine safety equipment property. File state return only Single purpose agricultural (livestock) or horticultural structures. File state return only Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary product of petroleum. File state return only Any railroad grading or tunnel bore. File state return only Buildings and structural components. File state return only   Section 1245 property does not include buildings and structural components. File state return only The term building includes a house, barn, warehouse, or garage. File state return only The term structural component includes walls, floors, windows, doors, central air conditioning systems, light fixtures, etc. File state return only   Do not treat a structure that is essentially machinery or equipment as a building or structural component. File state return only Also, do not treat a structure that houses property used as an integral part of an activity as a building or structural component if the structure's use is so closely related to the property's use that the structure can be expected to be replaced when the property it initially houses is replaced. File state return only   The fact that the structure is specially designed to withstand the stress and other demands of the property and cannot be used economically for other purposes indicates it is closely related to the use of the property it houses. File state return only Structures such as oil and gas storage tanks, grain storage bins, silos, fractionating towers, blast furnaces, basic oxygen furnaces, coke ovens, brick kilns, and coal tipples are not treated as buildings, but as section 1245 property. File state return only Facility for bulk storage of fungible commodities. File state return only   This term includes oil or gas storage tanks and grain storage bins. File state return only Bulk storage means the storage of a commodity in a large mass before it is used. File state return only For example, if a facility is used to store oranges that have been sorted and boxed, it is not used for bulk storage. File state return only To be fungible, a commodity must be such that one part may be used in place of another. File state return only   Stored materials that vary in composition, size, and weight are not fungible. File state return only Materials are not fungible if one part cannot be used in place of another part and the materials cannot be estimated and replaced by simple reference to weight, measure, and number. File state return only For example, the storage of different grades and forms of aluminum scrap is not storage of fungible commodities. File state return only Gain Treated as Ordinary Income The gain treated as ordinary income on the sale, exchange, or involuntary conversion of section 1245 property, including a sale and leaseback transaction, is the lesser of the following amounts. File state return only The depreciation and amortization allowed or allowable on the property. File state return only The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property). File state return only A limit on this amount for gain on like-kind exchanges and involuntary conversions is explained later. File state return only For any other disposition of section 1245 property, ordinary income is the lesser of (1) earlier or the amount by which its fair market value is more than its adjusted basis. File state return only See Gifts and Transfers at Death, later. File state return only Use Part III of Form 4797 to figure the ordinary income part of the gain. File state return only Depreciation taken on other property or taken by other taxpayers. File state return only   Depreciation and amortization include the amounts you claimed on the section 1245 property as well as the following depreciation and amortization amounts. File state return only Amounts you claimed on property you exchanged for, or converted to, your section 1245 property in a like-kind exchange or involuntary conversion. File state return only Amounts a previous owner of the section 1245 property claimed if your basis is determined with reference to that person's adjusted basis (for example, the donor's depreciation deductions on property you received as a gift). File state return only Depreciation and amortization. File state return only   Depreciation and amortization that must be recaptured as ordinary income include (but are not limited to) the following items. File state return only Ordinary depreciation deductions. File state return only Any special depreciation allowance you claimed. File state return only Amortization deductions for all the following costs. File state return only Acquiring a lease. File state return only Lessee improvements. File state return only Certified pollution control facilities. File state return only Certain reforestation expenses. File state return only Section 197 intangibles. File state return only Childcare facility expenses made before 1982, if in effect before the repeal of IRC 188. File state return only Franchises, trademarks, and trade names acquired before August 11, 1993. File state return only The section 179 deduction. File state return only Deductions for all the following costs. File state return only Removing barriers to the disabled and the elderly. File state return only Tertiary injectant expenses. File state return only Depreciable clean-fuel vehicles and refueling property (minus the amount of any recaptured deduction). File state return only Environmental cleanup costs. File state return only Certain reforestation expenses. File state return only Qualified disaster expenses. File state return only Any basis reduction for the investment credit (minus any basis increase for credit recapture). File state return only Any basis reduction for the qualified electric vehicle credit (minus any basis increase for credit recapture). File state return only Example. File state return only You file your returns on a calendar year basis. File state return only In February 2011, you bought and placed in service for 100% use in your business a light-duty truck (5-year property) that cost $10,000. File state return only You used the half-year convention and your MACRS deductions for the truck were $2,000 in 2011 and $3,200 in 2012. File state return only You did not take the section 179 deduction. File state return only You sold the truck in May 2013 for $7,000. File state return only The MACRS deduction in 2013, the year of sale, is $960 (½ of $1,920). File state return only Figure the gain treated as ordinary income as follows. File state return only 1) Amount realized $7,000 2) Cost (February 2011) $10,000   3) Depreciation allowed or allowable (MACRS deductions: $2,000 + $3,200 + $960) 6,160   4) Adjusted basis (subtract line 3 from line 2) $3,840 5) Gain realized (subtract line 4 from line 1) $3,160 6) Gain treated as ordinary income (lesser of line 3 or line 5) $3,160 Depreciation on other tangible property. File state return only   You must take into account depreciation during periods when the property was not used as an integral part of an activity or did not constitute a research or storage facility, as described earlier under Section 1245 property. File state return only   For example, if depreciation deductions taken on certain storage facilities amounted to $10,000, of which $6,000 is from the periods before their use in a prescribed business activity, you must use the entire $10,000 in determining ordinary income from depreciation. File state return only Depreciation allowed or allowable. File state return only   The greater of the depreciation allowed or allowable is generally the amount to use in figuring the part of gain to report as ordinary income. File state return only However, if in prior years, you have consistently taken proper deductions under one method, the amount allowed for your prior years will not be increased even though a greater amount would have been allowed under another proper method. File state return only If you did not take any deduction at all for depreciation, your adjustments to basis for depreciation allowable are figured by using the straight line method. File state return only   This treatment applies only when figuring what part of gain is treated as ordinary income under the rules for section 1245 depreciation recapture. File state return only Multiple asset accounts. File state return only   In figuring ordinary income from depreciation, you can treat any number of units of section 1245 property in a single depreciation account as one item if the total ordinary income from depreciation figured by using this method is not less than it would be if depreciation on each unit were figured separately. File state return only Example. File state return only In one transaction you sold 50 machines, 25 trucks, and certain other property that is not section 1245 property. File state return only All of the depreciation was recorded in a single depreciation account. File state return only After dividing the total received among the various assets sold, you figured that each unit of section 1245 property was sold at a gain. File state return only You can figure the ordinary income from depreciation as if the 50 machines and 25 trucks were one item. File state return only However, if five of the trucks had been sold at a loss, only the 50 machines and 20 of the trucks could be treated as one item in determining the ordinary income from depreciation. File state return only Normal retirement. File state return only   The normal retirement of section 1245 property in multiple asset accounts does not require recognition of gain as ordinary income from depreciation if your method of accounting for asset retirements does not require recognition of that gain. File state return only Section 1250 Property Gain on the disposition of section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable on the property. File state return only To determine the additional depreciation on section 1250 property, see Additional Depreciation, below. File state return only Section 1250 property defined. File state return only   This includes all real property that is subject to an allowance for depreciation and that is not and never has been section 1245 property. File state return only It includes a leasehold of land or section 1250 property subject to an allowance for depreciation. File state return only A fee simple interest in land is not included because it is not depreciable. File state return only   If your section 1250 property becomes section 1245 property because you change its use, you can never again treat it as section 1250 property. File state return only Additional Depreciation If you hold section 1250 property longer than 1 year, the additional depreciation is the actual depreciation adjustments that are more than the depreciation figured using the straight line method. File state return only For a list of items treated as depreciation adjustments, see Depreciation and amortization under Gain Treated as Ordinary Income, earlier. File state return only For the treatment of unrecaptured section 1250 gain, see Capital Gains Tax Rate, later. File state return only If you hold section 1250 property for 1 year or less, all the depreciation is additional depreciation. File state return only You will not have additional depreciation if any of the following conditions apply to the property disposed of. File state return only You figured depreciation for the property using the straight line method or any other method that does not result in depreciation that is more than the amount figured by the straight line method; you held the property longer than 1 year; and, if the property was qualified property, you made a timely election not to claim any special depreciation allowance. File state return only In addition, if the property was in a renewal community, you must not have elected to claim a commercial revitalization deduction for property placed in service before January 1, 2010. File state return only The property was residential low-income rental property you held for 162/3 years or longer. File state return only For low-income rental housing on which the special 60-month depreciation for rehabilitation expenses was allowed, the 162/3 years start when the rehabilitated property is placed in service. File state return only You chose the alternate ACRS method for the property, which was a type of 15-, 18-, or 19-year real property covered by the section 1250 rules. File state return only The property was residential rental property or nonresidential real property placed in service after 1986 (or after July 31, 1986, if the choice to use MACRS was made); you held it longer than 1 year; and, if the property was qualified property, you made a timely election not to claim any special depreciation allowance. File state return only These properties are depreciated using the straight line method. File state return only In addition, if the property was in a renewal community, you must not have elected to claim a commercial revitalization deduction. File state return only Depreciation taken by other taxpayers or on other property. File state return only   Additional depreciation includes all depreciation adjustments to the basis of section 1250 property whether allowed to you or another person (as carryover basis property). File state return only Example. File state return only Larry Johnson gives his son section 1250 property on which he took $2,000 in depreciation deductions, of which $500 is additional depreciation. File state return only Immediately after the gift, the son's adjusted basis in the property is the same as his father's and reflects the $500 additional depreciation. File state return only On January 1 of the next year, after taking depreciation deductions of $1,000 on the property, of which $200 is additional depreciation, the son sells the property. File state return only At the time of sale, the additional depreciation is $700 ($500 allowed the father plus $200 allowed the son). File state return only Depreciation allowed or allowable. File state return only   The greater of depreciation allowed or allowable (to any person who held the property if the depreciation was used in figuring its adjusted basis in your hands) generally is the amount to use in figuring the part of the gain to be reported as ordinary income. File state return only If you can show that the deduction allowed for any tax year was less than the amount allowable, the lesser figure will be the depreciation adjustment for figuring additional depreciation. File state return only Retired or demolished property. File state return only   The adjustments reflected in adjusted basis generally do not include deductions for depreciation on retired or demolished parts of section 1250 property unless these deductions are reflected in the basis of replacement property that is section 1250 property. File state return only Example. File state return only A wing of your building is totally destroyed by fire. File state return only The depreciation adjustments figured in the adjusted basis of the building after the wing is destroyed do not include any deductions for depreciation on the destroyed wing unless it is replaced and the adjustments for depreciation on it are reflected in the basis of the replacement property. File state return only Figuring straight line depreciation. File state return only   The useful life and salvage value you would have used to figure straight line depreciation are the same as those used under the depreciation method you actually used. File state return only If you did not use a useful life under the depreciation method actually used (such as with the units-of-production method) or if you did not take salvage value into account (such as with the declining balance method), the useful life or salvage value for figuring what would have been the straight line depreciation is the useful life and salvage value you would have used under the straight line method. File state return only   Salvage value and useful life are not used for the ACRS method of depreciation. File state return only Figure straight line depreciation for ACRS real property by using its 15-, 18-, or 19-year recovery period as the property's useful life. File state return only   The straight line method is applied without any basis reduction for the investment credit. File state return only Property held by lessee. File state return only   If a lessee makes a leasehold improvement, the lease period for figuring what would have been the straight line depreciation adjustments includes all renewal periods. File state return only This inclusion of the renewal periods cannot extend the lease period taken into account to a period that is longer than the remaining useful life of the improvement. File state return only The same rule applies to the cost of acquiring a lease. File state return only   The term renewal period means any period for which the lease may be renewed, extended, or continued under an option exercisable by the lessee. File state return only However, the inclusion of renewal periods cannot extend the lease by more than two-thirds of the period that was the basis on which the actual depreciation adjustments were allowed. File state return only Applicable Percentage The applicable percentage used to figure the ordinary income because of additional depreciation depends on whether the real property you disposed of is nonresidential real property, residential rental property, or low-income housing. File state return only The percentages for these types of real property are as follows. File state return only Nonresidential real property. File state return only   For real property that is not residential rental property, the applicable percentage for periods after 1969 is 100%. File state return only For periods before 1970, the percentage is zero and no ordinary income because of additional depreciation before 1970 will result from its disposition. File state return only Residential rental property. File state return only   For residential rental property (80% or more of the gross income is from dwelling units) other than low-income housing, the applicable percentage for periods after 1975 is 100%. File state return only The percentage for periods before 1976 is zero. File state return only Therefore, no ordinary income because of additional depreciation before 1976 will result from a disposition of residential rental property. File state return only Low-income housing. File state return only    Low-income housing includes all the following types of residential rental property. File state return only Federally assisted housing projects if the mortgage is insured under section 221(d)(3) or 236 of the National Housing Act or housing financed or assisted by direct loan or tax abatement under similar provisions of state or local laws. File state return only Low-income rental housing for which a depreciation deduction for rehabilitation expenses was allowed. File state return only Low-income rental housing held for occupancy by families or individuals eligible to receive subsidies under section 8 of the United States Housing Act of 1937, as amended, or under provisions of state or local laws that authorize similar subsidies for low-income families. File state return only Housing financed or assisted by direct loan or insured under Title V of the Housing Act of 1949. File state return only   The applicable percentage for low-income housing is 100% minus 1% for each full month the property was held over 100 full months. File state return only If you have held low-income housing at least 16 years and 8 months, the percentage is zero and no ordinary income will result from its disposition. File state return only Foreclosure. File state return only   If low-income housing is disposed of because of foreclosure or similar proceedings, the monthly applicable percentage reduction is figured as if you disposed of the property on the starting date of the proceedings. File state return only Example. File state return only On June 1, 2001, you acquired low-income housing property. File state return only On April 3, 2012 (130 months after the property was acquired), foreclosure proceedings were started on the property and on December 3, 2013 (150 months after the property was acquired), the property was disposed of as a result of the foreclosure proceedings. File state return only The property qualifies for a reduced applicable percentage because it was held more than 100 full months. File state return only The applicable percentage reduction is 30% (130 months minus 100 months) rather than 50% (150 months minus 100 months) because it does not apply after April 3, 2012, the starting date of the foreclosure proceedings. File state return only Therefore, 70% of the additional depreciation is treated as ordinary income. File state return only Holding period. File state return only   The holding period used to figure the applicable percentage for low-income housing generally starts on the day after you acquired it. File state return only For example, if you bought low-income housing on January 1, 1997, the holding period starts on January 2, 1997. File state return only If you sold it on January 2, 2013, the holding period is exactly 192 full months. File state return only The applicable percentage for additional depreciation is 8%, or 100% minus 1% for each full month the property was held over 100 full months. File state return only Holding period for constructed, reconstructed, or erected property. File state return only   The holding period used to figure the applicable percentage for low-income housing you constructed, reconstructed, or erected starts on the first day of the month it is placed in service in a trade or business, in an activity for the production of income, or in a personal activity. File state return only Property acquired by gift or received in a tax-free transfer. File state return only   For low-income housing you acquired by gift or in a tax-free transfer the basis of which is figured by reference to the basis in the hands of the transferor, the holding period for the applicable percentage includes the holding period of the transferor. File state return only   If the adjusted basis of the property in your hands just after acquiring it is more than its adjusted basis to the transferor just before transferring it, the holding period of the difference is figured as if it were a separate improvement. File state return only See Low-Income Housing With Two or More Elements, next. File state return only Low-Income Housing With Two or More Elements If you dispose of low-income housing property that has two or more separate elements, the applicable percentage used to figure ordinary income because of additional depreciation may be different for each element. File state return only The gain to be reported as ordinary income is the sum of the ordinary income figured for each element. File state return only The following are the types of separate elements. File state return only A separate improvement (defined below). File state return only The basic section 1250 property plus improvements not qualifying as separate improvements. File state return only The units placed in service at different times before all the section 1250 property is finished. File state return only For example, this happens when a taxpayer builds an apartment building of 100 units and places 30 units in service (available for renting) on January 4, 2011, 50 on July 18, 2011, and the remaining 20 on January 18, 2012. File state return only As a result, the apartment house consists of three separate elements. File state return only The 36-month test for separate improvements. File state return only   A separate improvement is any improvement (qualifying under The 1-year test, below) added to the capital account of the property, but only if the total of the improvements during the 36-month period ending on the last day of any tax year is more than the greatest of the following amounts. File state return only Twenty-five percent of the adjusted basis of the property at the start of the first day of the 36-month period, or the first day of the holding period of the property, whichever is later. File state return only Ten percent of the unadjusted basis (adjusted basis plus depreciation and amortization adjustments) of the property at the start of the period determined in (1). File state return only $5,000. File state return only The 1-year test. File state return only   An addition to the capital account for any tax year (including a short tax year) is treated as an improvement only if the sum of all additions for the year is more than the greater of $2,000 or 1% of the unadjusted basis of the property. File state return only The unadjusted basis is figured as of the start of that tax year or the holding period of the property, whichever is later. File state return only In applying the 36-month test, improvements in any one of the 3 years are omitted entirely if the total improvements in that year do not qualify under the 1-year test. File state return only Example. File state return only The unadjusted basis of a calendar year taxpayer's property was $300,000 on January 1 of this year. File state return only During the year, the taxpayer made improvements A, B, and C, which cost $1,000, $600, and $700, respectively. File state return only The sum of the improvements, $2,300, is less than 1% of the unadjusted basis ($3,000), so the improvements do not satisfy the 1-year test and are not treated as improvements for the 36-month test. File state return only However, if improvement C had cost $1,500, the sum of these improvements would have been $3,100. File state return only Then, it would be necessary to apply the 36-month test to figure if the improvements must be treated as separate improvements. File state return only Addition to the capital account. File state return only   Any addition to the capital account made after the initial acquisition or completion of the property by you or any person who held the property during a period included in your holding period is to be considered when figuring the total amount of separate improvements. File state return only   The addition to the capital account of depreciable real property is the gross addition not reduced by amounts attributable to replaced property. File state return only For example, if a roof with an adjusted basis of $20,000 is replaced by a new roof costing $50,000, the improvement is the gross addition to the account, $50,000, and not the net addition of $30,000. File state return only The $20,000 adjusted basis of the old roof is no longer reflected in the basis of the property. File state return only The status of an addition to the capital account is not affected by whether it is treated as a separate property for determining depreciation deductions. File state return only   Whether an expense is treated as an addition to the capital account may depend on the final disposition of the entire property. File state return only If the expense item property and the basic property are sold in two separate transactions, the entire section 1250 property is treated as consisting of two distinct properties. File state return only Unadjusted basis. File state return only   In figuring the unadjusted basis as of a certain date, include the actual cost of all previous additions to the capital account plus those that did not qualify as separate improvements. File state return only However, the cost of components retired before that date is not included in the unadjusted basis. File state return only Holding period. File state return only   Use the following guidelines for figuring the applicable percentage for property with two or more elements. File state return only The holding period of a separate element placed in service before the entire section 1250 property is finished starts on the first day of the month that the separate element is placed in service. File state return only The holding period for each separate improvement qualifying as a separate element starts on the day after the improvement is acquired or, for improvements constructed, reconstructed, or erected, the first day of the month that the improvement is placed in service. File state return only The holding period for each improvement not qualifying as a separate element takes the holding period of the basic property. File state return only   If an improvement by itself does not meet the 1-year test (greater of $2,000 or 1% of the unadjusted basis), but it does qualify as a separate improvement that is a separate element (when grouped with other improvements made during the tax year), determine the start of its holding period as follows. File state return only Use the first day of a calendar month that is closest to the middle of the tax year. File state return only If there are two first days of a month that are equally close to the middle of the year, use the earlier date. File state return only Figuring ordinary income attributable to each separate element. File state return only   Figure ordinary income attributable to each separate element as follows. File state return only   Step 1. File state return only Divide the element's additional depreciation after 1975 by the sum of all the elements' additional depreciation after 1975 to determine the percentage used in Step 2. File state return only   Step 2. File state return only Multiply the percentage figured in Step 1 by the lesser of the additional depreciation after 1975 for the entire property or the gain from disposition of the entire property (the difference between the fair market value or amount realized and the adjusted basis). File state return only   Step 3. File state return only Multiply the result in Step 2 by the applicable percentage for the element. File state return only Example. File state return only You sold at a gain of $25,000 low-income housing property subject to the ordinary income rules of section 1250. File state return only The property consisted of four elements (W, X, Y, and Z). File state return only Step 1. File state return only The additional depreciation for each element is: W-$12,000; X-None; Y-$6,000; and Z-$6,000. File state return only The sum of the additional depreciation for all the elements is $24,000. File state return only Step 2. File state return only The depreciation deducted on element X was $4,000 less than it would have been under the straight line method. File state return only Additional depreciation on the property as a whole is $20,000 ($24,000 − $4,000). File state return only $20,000 is lower than the $25,000 gain on the sale, so $20,000 is used in Step 2. File state return only Step 3. File state return only The applicable percentages to be used in Step 3 for the elements are: W-68%; X-85%; Y-92%; and Z-100%. File state return only From these facts, the sum of the ordinary income for each element is figured as follows. File state return only   Step 1 Step 2 Step 3 Ordinary Income W . File state return only 50 $10,000 68% $ 6,800 X -0- -0- 85% -0- Y . File state return only 25 5,000 92% 4,600 Z . File state return only 25 5,000 100% 5,000 Sum of ordinary income of separate elements $16,400 Gain Treated as Ordinary Income To find what part of the gain from the disposition of section 1250 property is treated as ordinary income, follow these steps. File state return only In a sale, exchange, or involuntary conversion of the property, figure the amount realized that is more than the adjusted basis of the property. File state return only In any other disposition of the property, figure the fair market value that is more than the adjusted basis. File state return only Figure the additional depreciation for the periods after 1975. File state return only Multiply the lesser of (1) or (2) by the applicable percentage, discussed earlier under Applicable Percentage. File state return only Stop here if this is residential rental property or if (2) is equal to or more than (1). File state return only This is the gain treated as ordinary income because of additional depreciation. File state return only Subtract (2) from (1). File state return only Figure the additional depreciation for periods after 1969 but before 1976. File state return only Add the lesser of (4) or (5) to the result in (3). File state return only This is the gain treated as ordinary income because of additional depreciation. File state return only A limit on the amount treated as ordinary income for gain on like-kind exchanges and involuntary conversions is explained later. File state return only Use Form 4797, Part III, to figure the ordinary income part of the gain. File state return only Corporations. File state return only   Corporations, other than S corporations, must recognize an additional amount as ordinary income on the sale or other disposition of section 1250 property. File state return only The additional amount treated as ordinary income is 20% of the excess of the amount that would have been ordinary income if the property were section 1245 property over the amount treated as ordinary income under section 1250. File state return only Report this additional ordinary income on Form 4797, Part III, line 26 (f). File state return only Installment Sales If you report the sale of property under the installment method, any depreciation recapture under section 1245 or 1250 is taxable as ordinary income in the year of sale. File state return only This applies even if no payments are received in that year. File state return only If the gain is more than the depreciation recapture income, report the rest of the gain using the rules of the installment method. File state return only For this purpose, include the recapture income in your installment sale basis to determine your gross profit on the installment sale. File state return only If you dispose of more than one asset in a single transaction, you must figure the gain on each asset separately so that it may be properly reported. File state return only To do this, allocate the selling price and the payments you receive in the year of sale to each asset. File state return only Report any depreciation recapture income in the year of sale before using the installment method for any remaining gain. File state return only For a detailed discussion of installment sales, see Publication 537. File state return only Gifts If you make a gift of depreciable personal property or real property, you do not have to report income on the transaction. File state return only However, if the person who receives it (donee) sells or otherwise disposes of the property in a disposition subject to recapture, the donee must take into account the depreciation you deducted in figuring the gain to be reported as ordinary income. File state return only For low-income housing, the donee must take into account the donor's holding period to figure the applicable percentage. File state return only See Applicable Percentage and its discussion Holding period under Section 1250 Property, earlier. File state return only Part gift and part sale or exchange. File state return only   If you transfer depreciable personal property or real property for less than its fair market value in a transaction considered to be partly a gift and partly a sale or exchange and you have a gain because the amount realized is more than your adjusted basis, you must report ordinary income (up to the amount of gain) to recapture depreciation. File state return only If the depreciation (additional depreciation, if section 1250 property) is more than the gain, the balance is carried over to the transferee to be taken into account on any later disposition of the property. File state return only However, see Bargain sale to charity, later. File state return only Example. File state return only You transferred depreciable personal property to your son for $20,000. File state return only When transferred, the property had an adjusted basis to you of $10,000 and a fair market value of $40,000. File state return only You took depreciation of $30,000. File state return only You are considered to have made a gift of $20,000, the difference between the $40,000 fair market value and the $20,000 sale price to your son. File state return only You have a taxable gain on the transfer of $10,000 ($20,000 sale price minus $10,000 adjusted basis) that must be reported as ordinary income from depreciation. File state return only You report $10,000 of your $30,000 depreciation as ordinary income on the transfer of the property, so the remaining $20,000 depreciation is carried over to your son for him to take into account on any later disposition of the property. File state return only Gift to charitable organization. File state return only   If you give property to a charitable organization, you figure your deduction for your charitable contribution by reducing the fair market value of the property by the ordinary income and short-term capital gain that would have resulted had you sold the property at its fair market value at the time of the contribution. File state return only Thus, your deduction for depreciable real or personal property given to a charitable organization does not include the potential ordinary gain from depreciation. File state return only   You also may have to reduce the fair market value of the contributed property by the long-term capital gain (including any section 1231 gain) that would have resulted had the property been sold. File state return only For more information, see Giving Property That Has Increased in Value in Publication 526. File state return only Bargain sale to charity. File state return only   If you transfer section 1245 or section 1250 property to a charitable organization for less than its fair market value and a deduction for the contribution part of the transfer is allowable, your ordinary income from depreciation is figured under different rules. File state return only First, figure the ordinary income as if you had sold the property at its fair market value. File state return only Then, allocate that amount between the sale and the contribution parts of the transfer in the same proportion that you allocated your adjusted basis in the property to figure your gain. File state return only See Bargain Sale under Gain or Loss From Sales and Exchanges in chapter 1. File state return only Report as ordinary income the lesser of the ordinary income allocated to the sale or your gain from the sale. File state return only Example. File state return only You sold section 1245 property in a bargain sale to a charitable organization and are allowed a deduction for your contribution. File state return only Your gain on the sale was $1,200, figured by allocating 20% of your adjusted basis in the property to the part sold. File state return only If you had sold the property at its fair market value, your ordinary income would have been $5,000. File state return only Your ordinary income is $1,000 ($5,000 × 20%) and your section 1231 gain is $200 ($1,200 – $1,000). File state return only Transfers at Death When a taxpayer dies, no gain is reported on depreciable personal property or real property transferred to his or her estate or beneficiary. File state return only For information on the tax liability of a decedent, see Publication 559, Survivors, Executors, and Administrators. File state return only However, if the decedent disposed of the property while alive and, because of his or her method of accounting or for any other reason, the gain from the disposition is reportable by the estate or beneficiary, it must be reported in the same way the decedent would have had to report it if he or she were still alive. File state return only Ordinary income due to depreciation must be reported on a transfer from an executor, administrator, or trustee to an heir, beneficiary, or other individual if the transfer is a sale or exchange on which gain is realized. File state return only Example 1. File state return only Janet Smith owned depreciable property that, upon her death, was inherited by her son. File state return only No ordinary income from depreciation is reportable on the transfer, even though the value used for estate tax purposes is more than the adjusted basis of the property to Janet when she died. File state return only However, if she sold the property before her death and realized a gain and if, because of her method of accounting, the proceeds from the sale are income in respect of a decedent reportable by her son, he must report ordinary income from depreciation. File state return only Example 2. File state return only The trustee of a trust created by a will transfers depreciable property to a beneficiary in satisfaction of a specific bequest of $10,000. File state return only If the property had a value of $9,000 at the date used for estate tax valuation purposes, the $1,000 increase in value to the date of distribution is a gain realized by the trust. File state return only Ordinary income from depreciation must be reported by the trust on the transfer. File state return only Like-Kind Exchanges and Involuntary Conversions A like-kind exchange of your depreciable property or an involuntary conversion of the property into similar or related property will not result in your having to report ordinary income from depreciation unless money or property other than like-kind, similar, or related property is also received in the transaction. File state return only For information on like-kind exchanges and involuntary conversions, see chapter 1. File state return only Depreciable personal property. File state return only   If you have a gain from either a like-kind exchange or an involuntary conversion of your depreciable personal property, the amount to be reported as ordinary income from depreciation is the amount figured under the rules explained earlier (see Section 1245 Property), limited to the sum of the following amounts. File state return only The gain that must be included in income under the rules for like-kind exchanges or involuntary conversions. File state return only The fair market value of the like-kind, similar, or related property other than depreciable personal property acquired in the transaction. File state return only Example 1. File state return only You bought a new machine for $4,300 cash plus your old machine for which you were allowed a $1,360 trade-in. File state return only The old machine cost you $5,000 two years ago. File state return only You took depreciation deductions of $3,950. File state return only Even though you deducted depreciation of $3,950, the $310 gain ($1,360 trade-in allowance minus $1,050 adjusted basis) is not reported because it is postponed under the rules for like-kind exchanges and you received only depreciable personal property in the exchange. File state return only Example 2. File state return only You bought office machinery for $1,500 two years ago and deducted $780 depreciation. File state return only This year a fire destroyed the machinery and you received $1,200 from your fire insurance, realizing a gain of $480 ($1,200 − $720 adjusted basis). File state return only You choose to postpone reporting gain, but replacement machinery cost you only $1,000. File state return only Your taxable gain under the rules for involuntary conversions is limited to the remaining $200 insurance payment. File state return only All your replacement property is depreciable personal property, so your ordinary income from depreciation is limited to $200. File state return only Example 3. File state return only A fire destroyed office machinery you bought for $116,000. File state return only The depreciation deductions were $91,640 and the machinery had an adjusted basis of $24,360. File state return only You received a $117,000 insurance payment, realizing a gain of $92,640. File state return only You immediately spent $105,000 of the insurance payment for replacement machinery and $9,000 for stock that qualifies as replacement property and you choose to postpone reporting the gain. File state return only $114,000 of the $117,000 insurance payment was used to buy replacement property, so the gain that must be included in income under the rules for involuntary conversions is the part not spent, or $3,000. File state return only The part of the insurance payment ($9,000) used to buy the nondepreciable property (the stock) also must be included in figuring the gain from depreciation. File state return only The amount you must report as ordinary income on the transaction is $12,000, figured as follows. File state return only 1) Gain realized on the transaction ($92,640) limited to depreciation ($91,640) $91,640 2) Gain includible in income (amount not spent) 3,000     Plus: fair market value of property other than depreciable personal property (the stock) 9,000 12,000 Amount reportable as ordinary income (lesser of (1) or (2)) $12,000   If, instead of buying $9,000 in stock, you bought $9,000 worth of depreciable personal property similar or related in use to the destroyed property, you would only report $3,000 as ordinary income. File state return only Depreciable real property. File state return only   If you have a gain from either a like-kind exchange or involuntary conversion of your depreciable real property, ordinary income from additional depreciation is figured under the rules explained earlier (see Section 1250 Property), limited to the greater of the following amounts. File state return only The gain that must be reported under the rules for like-kind exchanges or involuntary conversions plus the fair market value of stock bought as replacement property in acquiring control of a corporation. File state return only The gain you would have had to report as ordinary income from additional depreciation had the transaction been a cash sale minus the cost (or fair market value in an exchange) of the depreciable real property acquired. File state return only   The ordinary income not reported for the year of the disposition is carried over to the depreciable real property acquired in the like-kind exchange or involuntary conversion as additional depreciation from the property disposed of. File state return only Further, to figure the applicable percentage of additional depreciation to be treated as ordinary income, the holding period starts over for the new property. File state return only Example. File state return only The state paid you $116,000 when it condemned your depreciable real property for public use. File state return only You bought other real property similar in use to the property condemned for $110,000 ($15,000 for depreciable real property and $95,000 for land). File state return only You also bought stock for $5,000 to get control of a corporation owning property similar in use to the property condemned. File state return only You choose to postpone reporting the gain. File state return only If the transaction had been a sale for cash only, under the rules described earlier, $20,000 would have been reportable as ordinary income because of additional depreciation. File state return only The ordinary income to be reported is $6,000, which is the greater of the following amounts. File state return only The gain that must be reported under the rules for involuntary conversions, $1,000 ($116,000 − $115,000) plus the fair market value of stock bought as qualified replacement property, $5,000, for a total of $6,000. File state return only The gain you would have had to report as ordinary income from additional depreciation ($20,000) had this transaction been a cash sale minus the cost of the depreciable real property bought ($15,000), or $5,000. File state return only   The ordinary income not reported, $14,000 ($20,000 − $6,000), is carried over to the depreciable real property you bought as additional depreciation. File state return only Basis of property acquired. File state return only   If the ordinary income you have to report because of additional depreciation is limited, the total basis of the property you acquired is its fair market value (its cost, if bought to replace property involuntarily converted into money) minus the gain postponed. File state return only   If you acquired more than one item of property, allocate the total basis among the properties in proportion to their fair market value (their cost, in an involuntary conversion into money). File state return only However, if you acquired both depreciable real property and other property, allocate the total basis as follows. File state return only Subtract the ordinary income because of additional depreciation that you do not have to report from the fair market value (or cost) of the depreciable real property acquired. File state return only Add the fair market value (or cost) of the other property acquired to the result in (1). File state return only Divide the result in (1) by the result in (2). File state return only Multiply the total basis by the result in (3). File state return only This is the basis of the depreciable real property acquired. File state return only If you acquired more than one item of depreciable real property, allocate this basis amount among the properties in proportion to their fair market value (or cost). File state return only Subtract the result in (4) from the total basis. File state return only This is the basis of the other property acquired. File state return only If you acquired more than one item of other property, allocate this basis amount among the properties in proportion to their fair market value (or cost). File state return only Example 1. File state return only In 1988, low-income housing property that you acquired and placed in service in 1983 was destroyed by fire and you received a $90,000 insurance payment. File state return only The property's adjusted basis was $38,400, with additional depreciation of $14,932. File state return only On December 1, 1988, you used the insurance payment to acquire and place in service replacement low-income housing property. File state return only Your realized gain from the involuntary conversion was $51,600 ($90,000 − $38,400). File state return only You chose to postpone reporting the gain under the involuntary conversion rules. File state return only Under the rules for depreciation recapture on real property, the ordinary gain was $14,932, but you did not have to report any of it because of the limit for involuntary conversions. File state return only The basis of the replacement low-income housing property was its $90,000 cost minus the $51,600 gain you postponed, or $38,400. File state return only The $14,932 ordinary gain you did not report is treated as additional depreciation on the replacement property. File state return only If you sold the property in 2013, your holding period for figuring the applicable percentage of additional depreciation to report as ordinary income will have begun December 2, 1988, the day after you acquired the property. File state return only Example 2. File state return only John Adams received a $90,000 fire insurance payment for depreciable real property (office building) with an adjusted basis of $30,000. File state return only He uses the whole payment to buy property similar in use, spending $42,000 for depreciable real property and $48,000 for land. File state return only He chooses to postpone reporting the $60,000 gain realized on the involuntary conversion. File state return only Of this gain, $10,000 is ordinary income from additional depreciation but is not reported because of the limit for involuntary conversions of depreciable real property. File state return only The basis of the property bought is $30,000 ($90,000 − $60,000), allocated as follows. File state return only The $42,000 cost of depreciable real property minus $10,000 ordinary income not reported is $32,000. File state return only The $48,000 cost of other property (land) plus the $32,000 figured in (1) is $80,000. File state return only The $32,000 figured in (1) divided by the $80,000 figured in (2) is 0. File state return only 4. File state return only The basis of the depreciable real property is $12,000. File state return only This is the $30,000 total basis multiplied by the 0. File state return only 4 figured in (3). File state return only The basis of the other property (land) is $18,000. File state return only This is the $30,000 total basis minus the $12,000 figured in (4). File state return only The ordinary income that is not reported ($10,000) is carried over as additional depreciation to the depreciable real property that was bought and may be taxed as ordinary income on a later disposition. File state return only Multiple Properties If you dispose of depreciable property and other property in one transaction and realize a gain, you must allocate the amount realized between the two types of property in proportion to their respective fair market values to figure the part of your gain to be reported as ordinary income from depreciation. File state return only Different rules may apply to the allocation of the amount realized on the sale of a business that includes a group of assets. File state return only See chapter 2. File state return only In general, if a buyer and seller have adverse interests as to the allocation of the amount realized between the depreciable property and other property, any arm's length agreement between them will establish the allocation. File state return only In the absence of an agreement, the allocation should be made by taking into account the appropriate facts and circumstances. File state return only These include, but are not limited to, a comparison between the depreciable property and all the other property being disposed of in the transaction. File state return only The comparison should take into account all the following facts and circumstances. File state return only The original cost and reproduction cost of construction, erection, or production. File state return only The remaining economic useful life. File state return only The state of obsolescence. File state return only The anticipated expenditures required to maintain, renovate, or modernize the properties. File state return only Like-kind exchanges and involuntary conversions. File state return only   If you dispose of and acquire depreciable personal property and other property (other than depreciable real property) in a like-kind exchange or involuntary conversion, the amount realized is allocated in the following way. File state return only The amount allocated to the depreciable personal property disposed of is treated as consisting of, first, the fair market value of the depreciable personal property acquired and, second (to the extent of any remaining balance), the fair market value of the other property acquired. File state return only The amount allocated to the other property disposed of is treated as consisting of the fair market value of all property acquired that has not already been taken into account. File state return only   If you dispose of and acquire depreciable real property and other property in a like-kind exchange or involuntary conversion, the amount realized is allocated in the following way. File state return only The amount allocated to each of the three types of property (depreciable real property, depreciable personal property, or other property) disposed of is treated as consisting of, first, the fair market value of that type of property acquired and, second (to the extent of any remaining balance), any excess fair market value of the other types of property acquired. File state return only If the excess fair market value is more than the remaining balance of the amount realized and is from both of the other two types of property, you can apply the unallocated amount in any manner you choose. File state return only Example. File state return only A fire destroyed your property with a total fair market value of $50,000. File state return only It consisted of machinery worth $30,000 and nondepreciable property worth $20,000. File state return only You received an insurance payment of $40,000 and immediately used it with $10,000 of your own funds (for a total of $50,000) to buy machinery with a fair market value of $15,000 and nondepreciable property with a fair market value of $35,000. File state return only The adjusted basis of the destroyed machinery was $5,000 and your depreciation on it was $35,000. File state return only You choose to postpone reporting your gain from the involuntary conversion. File state return only You must report $9,000 as ordinary income from depreciation arising from this transaction, figured as follows. File state return only The $40,000 insurance payment must be allocated between the machinery and the other property destroyed in proportion to the fair market value of each. File state return only The amount allocated to the machinery is 30,000/50,000 × $40,000, or $24,000. File state return only The amount allocated to the other property is 20,000/50,000 × $40,000, or $16,000. File state return only Your gain on the involuntary conversion of the machinery is $24,000 minus $5,000 adjusted basis, or $19,000. File state return only The $24,000 allocated to the machinery disposed of is treated as consisting of the $15,000 fair market value of the replacement machinery bought and $9,000 of the fair market value of other property bought in the transaction. File state return only All $16,000 allocated to the other property disposed of is treated as consisting of the fair market value of the other property that was bought. File state return only Your potential ordinary income from depreciation is $19,000, the gain on the machinery, because it is less than the $35,000 depreciation. File state return only However, the amount you must report as ordinary income is limited to the $9,000 included in the amount realized for the machinery that represents the fair market value of property other than the depreciable property you bought. File state return only Prev  Up  Next   Home   More Online Publications
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Contact My Local Office in Minnesota

Face-to-face Tax Help

IRS Taxpayer Assistance Centers (TACs) are your source for personal tax help when you believe your tax issue can only be handled face-to-face. No appointment is necessary.

Keep in mind, many questions can be resolved online without waiting in line. Through IRS.gov you can:
• Set up a payment plan.
• Get a transcript of your tax return.
• Make a payment.
• Check on your refund.
• Find answers to many of your tax questions.

We are now referring all requests for tax return preparation services to other available resources. You can take advantage of free tax preparation through Free File, Free File Fillable Forms or through a volunteer site in your community. To find the nearest volunteer site location or to get more information about Free File, go to the top of the page and enter “Free Tax Help” in the Search box.

If you have a tax account issues and feel that it requires talking with someone face-to-face, visit your local TAC.

Caution:  Many of our offices are located in Federal Office Buildings. These buildings may not allow visitors to bring in cell phones with camera capabilities.

Multilingual assistance is available in every office. Hours of operation are subject to change.

Before visiting your local office click on "Services Provided" in the chart below to see what services are available. Services are limited and not all services are available at every TAC office and may vary from site to site. You can get these services on a walk-in basis.

City Street Address Days/Hours of Service Telephone*
Bloomington 1550 American Blvd. East
Suite 700
Bloomington, MN 55425

Monday-Friday - 8:30 a.m.- 4:30 p.m.
(Closed for lunch 11:30 a.m. - 12:30 p.m.)

 

**This office will be open until 6:00 p.m. on 4/14 & 4/15**
 

Services Provided

(651) 312-8082 
Duluth  515 W. First St.
Duluth, MN 55802 

Monday-Friday - 8:30 a.m.- 4:30 p.m.
(Closed for lunch 11:30 a.m.-12:30 p.m.)
 

Services Provided

(218) 626-1624 
Mankato  1921 Excel Dr.
Mankato, MN 56001 

Monday-Friday - 8:30 a.m.- 4:30 p.m.
(Closed for lunch 11:30 a.m.-12:30 p.m.)

 

Services Provided

(507) 625-4977 
Minneapolis  250 Marquette Ave.
Minneapolis, MN 55401 

Monday-Friday - 8:30 a.m.- 4:30 p.m.
 

Services Provided

(651) 312-8082 
Rochester  310 South. Broadway
Rochester, MN 55904

Monday-Friday - 8:30 a.m.- 4:30 p.m.
(Closed for lunch 11:30 a.m.-12:30 p.m.)

 

Services Provided

(507) 281-3044 
St. Cloud  3800 8th Street North
St. Cloud, MN 56303 

Monday-Friday - 8:30 a.m.- 4:30 p.m.
(Closed for lunch 11:30 a.m.-12:30 p.m.)
 

Services Provided

(320) 251-9261 
St. Paul  430 North Wabasha Street
St. Paul, MN 55101
(Physical address only) 

Monday-Friday - 8:30 a.m.- 4:30 p.m.

 

Services Provided

(651) 312-8082 

* Note: The phone numbers in the chart above are not toll-free for all locations. When you call, you will reach a recorded business message with information about office hours, locations and services provided in that office. If face-to-face assistance is not a priority for you, you may also get help with IRS letters or resolve tax account issues by phone, toll free at 1-800-829-1040 (individuals) or 1-800-829-4933 (businesses).
 

For information on where to file your tax return please see Where to File Addresses

The Taxpayer Advocate Service: Call (651) 312-7999 in Minneapolis/St. Paul or 1-877-777-4778 elsewhere, or see Publication 1546, The Taxpayer Advocate Service of the IRS.

For further information, see Tax Topic 104

Partnerships

IRS and organizations all over the country are partnering to assist taxpayers. Through these partnerships, organizations are also achieving their own goals. These mutually beneficial partnerships are strengthening outreach efforts and bringing education and assistance to millions.

For more information about these programs for individuals and families, contact the Stakeholder Partnerships, Education and Communication Office at:

Internal Revenue Service
U.S. Bank Financial Center 
1550 American Blvd., E. 
Stop 6610 BLM, Suite 705
Bloomington, MN 55425

For more information about these programs for businesses, your local Stakeholder Liaison office establishes relationships with organizations representing small business and self-employed taxpayers. They provide information about the policies, practices and procedures the IRS uses to ensure compliance with the tax laws. To establish a relationship with us, use this list to find a contact in your state:

Stakeholder Liaison (SL) Phone Numbers for Organizations Representing Small Businesses and Self-employed Taxpayers.

Page Last Reviewed or Updated: 28-Mar-2014

The File State Return Only

File state return only Publication 541 - Main Content Table of Contents Forming a PartnershipOrganizations Classified as Partnerships Family Partnership Partnership Agreement Terminating a PartnershipIRS e-file (Electronic Filing) Exclusion From Partnership Rules Partnership Return (Form 1065) Partnership DistributionsSubstantially appreciated inventory items. File state return only Partner's Gain or Loss Partner's Basis for Distributed Property Transactions Between Partnership and PartnersGuaranteed Payments Sale or Exchange of Property Contribution of Property Contribution of Services Basis of Partner's InterestAdjusted Basis Effect of Partnership Liabilities Disposition of Partner's InterestSale, Exchange, or Other Transfer Payments for Unrealized Receivables and Inventory Items Liquidation at Partner's Retirement or Death Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)Partnership Item. File state return only Small Partnerships and the Small Partnership Exception Small Partnership TEFRA Election Role of Tax Matters Partner (TMP) in TEFRA Proceedings Statute of Limitations and TEFRA Amended Returns and Administrative Adjustment Requests (AARs) How To Get Tax Help Forming a Partnership The following sections contain general information about partnerships. File state return only Organizations Classified as Partnerships An unincorporated organization with two or more members is generally classified as a partnership for federal tax purposes if its members carry on a trade, business, financial operation, or venture and divide its profits. File state return only However, a joint undertaking merely to share expenses is not a partnership. File state return only For example, co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants. File state return only The rules you must use to determine whether an organization is classified as a partnership changed for organizations formed after 1996. File state return only Organizations formed after 1996. File state return only   An organization formed after 1996 is classified as a partnership for federal tax purposes if it has two or more members and it is none of the following. File state return only An organization formed under a federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic. File state return only An organization formed under a state law that refers to it as a joint-stock company or joint-stock association. File state return only An insurance company. File state return only Certain banks. File state return only An organization wholly owned by a state, local, or foreign government. File state return only An organization specifically required to be taxed as a corporation by the Internal Revenue Code (for example, certain publicly traded partnerships). File state return only Certain foreign organizations identified in section 301. File state return only 7701-2(b)(8) of the regulations. File state return only A tax-exempt organization. File state return only A real estate investment trust. File state return only An organization classified as a trust under section 301. File state return only 7701-4 of the regulations or otherwise subject to special treatment under the Internal Revenue Code. File state return only Any other organization that elects to be classified as a corporation by filing Form 8832. File state return only For more information, see the instructions for Form 8832. File state return only Limited liability company. File state return only   A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC. File state return only Unlike a partnership, none of the members of an LLC are personally liable for its debts. File state return only An LLC may be classified for federal income tax purposes as either a partnership, a corporation, or an entity disregarded as an entity separate from its owner by applying the rules in Regulations section 301. File state return only 7701-3. File state return only See Form 8832 and section 301. File state return only 7701-3 of the regulations for more details. File state return only A domestic LLC with at least two members that does not file Form 8832 is classified as a partnership for federal income tax purposes. File state return only Organizations formed before 1997. File state return only   An organization formed before 1997 and classified as a partnership under the old rules will generally continue to be classified as a partnership as long as the organization has at least two members and does not elect to be classified as a corporation by filing Form 8832. File state return only Community property. File state return only    Spouses who own a qualified entity (defined later) can choose to classify the entity as a partnership for federal tax purposes by filing the appropriate partnership tax returns. File state return only They can choose to classify the entity as a sole proprietorship by filing a Schedule C (Form 1040) listing one spouse as the sole proprietor. File state return only A change in reporting position will be treated for federal tax purposes as a conversion of the entity. File state return only   A qualified entity is a business entity that meets all the following requirements. File state return only The business entity is wholly owned by spouses as community property under the laws of a state, a foreign country, or a possession of the United States. File state return only No person other than one or both spouses would be considered an owner for federal tax purposes. File state return only The business entity is not treated as a corporation. File state return only   For more information about community property, see Publication 555, Community Property. File state return only Publication 555 discusses the community property laws of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. File state return only Family Partnership Members of a family can be partners. File state return only However, family members (or any other person) will be recognized as partners only if one of the following requirements is met. File state return only If capital is a material income-producing factor, they acquired their capital interest in a bona fide transaction (even if by gift or purchase from another family member), actually own the partnership interest, and actually control the interest. File state return only If capital is not a material income-producing factor, they joined together in good faith to conduct a business. File state return only They agreed that contributions of each entitle them to a share in the profits, and some capital or service has been (or is) provided by each partner. File state return only Capital is material. File state return only   Capital is a material income-producing factor if a substantial part of the gross income of the business comes from the use of capital. File state return only Capital is ordinarily an income-producing factor if the operation of the business requires substantial inventories or investments in plants, machinery, or equipment. File state return only Capital is not material. File state return only   In general, capital is not a material income-producing factor if the income of the business consists principally of fees, commissions, or other compensation for personal services performed by members or employees of the partnership. File state return only Capital interest. File state return only   A capital interest in a partnership is an interest in its assets that is distributable to the owner of the interest in either of the following situations. File state return only The owner withdraws from the partnership. File state return only The partnership liquidates. File state return only   The mere right to share in earnings and profits is not a capital interest in the partnership. File state return only Gift of capital interest. File state return only   If a family member (or any other person) receives a gift of a capital interest in a partnership in which capital is a material income-producing factor, the donee's distributive share of partnership income is subject to both of the following restrictions. File state return only It must be figured by reducing the partnership income by reasonable compensation for services the donor renders to the partnership. File state return only The donee's distributive share of partnership income attributable to donated capital must not be proportionately greater than the donor's distributive share attributable to the donor's capital. File state return only Purchase. File state return only   For purposes of determining a partner's distributive share, an interest purchased by one family member from another family member is considered a gift from the seller. File state return only The fair market value of the purchased interest is considered donated capital. File state return only For this purpose, members of a family include only spouses, ancestors, and lineal descendants (or a trust for the primary benefit of those persons). File state return only Example. File state return only A father sold 50% of his business to his son. File state return only The resulting partnership had a profit of $60,000. File state return only Capital is a material income-producing factor. File state return only The father performed services worth $24,000, which is reasonable compensation, and the son performed no services. File state return only The $24,000 must be allocated to the father as compensation. File state return only Of the remaining $36,000 of profit due to capital, at least 50%, or $18,000, must be allocated to the father since he owns a 50% capital interest. File state return only The son's share of partnership profit cannot be more than $18,000. File state return only Business owned and operated by spouses. File state return only   If spouses carry on a business together and share in the profits and losses, they may be partners whether or not they have a formal partnership agreement. File state return only If so, they should report income or loss from the business on Form 1065. File state return only They should not report the income on a Schedule C (Form 1040) in the name of one spouse as a sole proprietor. File state return only However, the spouses can elect not to treat the joint venture as a partnership by making a Qualified Joint Venture Election. File state return only Qualified Joint Venture Election. File state return only   A "qualified joint venture," whose only members are spouses filing a joint return, can elect not to be treated as a partnership for federal tax purposes. File state return only A qualified joint venture conducts a trade or business where: the only members of the joint venture are spouses filing jointly; both spouses elect not to be treated as a partnership; both spouses materially participate in the trade or business (see Passive Activity Limitations in the Instructions for Form 1065 for a definition of material participation); and the business is co-owned by both spouses and is not held in the name of a state law entity such as a partnership or LLC. File state return only   Under this election, a qualified joint venture conducted by spouses who file a joint return is not treated as a partnership for federal tax purposes and therefore does not have a Form 1065 filing requirement. File state return only All items of income, gain, deduction, loss, and credit are divided between the spouses based on their respective interests in the venture. File state return only Each spouse takes into account his or her respective share of these items as a sole proprietor. File state return only Each spouse would account for his or her respective share on the appropriate form, such as Schedule C (Form 1040). File state return only For purposes of determining net earnings from self-employment, each spouse's share of income or loss from a qualified joint venture is taken into account just as it is for federal income tax purposes (i. File state return only e. File state return only , based on their respective interests in the venture). File state return only   If the spouses do not make the election to treat their respective interests in the joint venture as sole proprietorships, each spouse should carry his or her share of the partnership income or loss from Schedule K-1 (Form 1065) to their joint or separate Form(s) 1040. File state return only Each spouse should include his or her respective share of self-employment income on a separate Schedule SE (Form 1040), Self-Employment Tax. File state return only   This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based. File state return only However, this may not be true if either spouse exceeds the social security tax limitation. File state return only   For more information on qualified joint ventures, go to IRS. File state return only gov, enter “Election for Qualified Joint Ventures” in the search box and select the link reading “Election for Husband and Wife Unincorporated Businesses. File state return only ” Partnership Agreement The partnership agreement includes the original agreement and any modifications. File state return only The modifications must be agreed to by all partners or adopted in any other manner provided by the partnership agreement. File state return only The agreement or modifications can be oral or written. File state return only Partners can modify the partnership agreement for a particular tax year after the close of the year but not later than the date for filing the partnership return for that year. File state return only This filing date does not include any extension of time. File state return only If the partnership agreement or any modification is silent on any matter, the provisions of local law are treated as part of the agreement. File state return only Terminating a Partnership A partnership terminates when one of the following events takes place. File state return only All its operations are discontinued and no part of any business, financial operation, or venture is continued by any of its partners in a partnership. File state return only At least 50% of the total interest in partnership capital and profits is sold or exchanged within a 12-month period, including a sale or exchange to another partner. File state return only Unlike other partnerships, an electing large partnership does not terminate on the sale or exchange of 50% or more of the partnership interests within a 12-month period. File state return only See section 1. File state return only 708-1(b) of the regulations for more information on the termination of a partnership. File state return only For special rules that apply to a merger, consolidation, or division of a partnership, see sections 1. File state return only 708-1(c) and 1. File state return only 708-1(d) of the regulations. File state return only Date of termination. File state return only   The partnership's tax year ends on the date of termination. File state return only For the event described in (1), above, the date of termination is the date the partnership completes the winding up of its affairs. File state return only For the event described in (2), above, the date of termination is the date of the sale or exchange of a partnership interest that, by itself or together with other sales or exchanges in the preceding 12 months, transfers an interest of 50% or more in both capital and profits. File state return only Short period return. File state return only   If a partnership is terminated before the end of what would otherwise be its tax year, Form 1065 must be filed for the short period, which is the period from the beginning of the tax year through the date of termination. File state return only The return is due the 15th day of the fourth month following the date of termination. File state return only See Partnership Return (Form 1065), later, for information about filing Form 1065. File state return only Conversion of partnership into limited liability company (LLC). File state return only   The conversion of a partnership into an LLC classified as a partnership for federal tax purposes does not terminate the partnership. File state return only The conversion is not a sale, exchange, or liquidation of any partnership interest; the partnership's tax year does not close; and the LLC can continue to use the partnership's taxpayer identification number. File state return only   However, the conversion may change some of the partners' bases in their partnership interests if the partnership has recourse liabilities that become nonrecourse liabilities. File state return only Because the partners share recourse and nonrecourse liabilities differently, their bases must be adjusted to reflect the new sharing ratios. File state return only If a decrease in a partner's share of liabilities exceeds the partner's basis, he or she must recognize gain on the excess. File state return only For more information, see Effect of Partnership Liabilities under Basis of Partner's Interest, later. File state return only   The same rules apply if an LLC classified as a partnership is converted into a partnership. File state return only IRS e-file (Electronic Filing) Please click here for the text description of the image. File state return only e-file Certain partnerships with more than 100 partners are required to file Form 1065, Schedules K-1, and related forms and schedules electronically (e-file). File state return only Other partnerships generally have the option to file electronically. File state return only For details about IRS e-file, see the Form 1065 instructions. File state return only Exclusion From Partnership Rules Certain partnerships that do not actively conduct a business can choose to be completely or partially excluded from being treated as partnerships for federal income tax purposes. File state return only All the partners must agree to make the choice, and the partners must be able to compute their own taxable income without computing the partnership's income. File state return only However, the partners are not exempt from the rule that limits a partner's distributive share of partnership loss to the adjusted basis of the partner's partnership interest. File state return only Nor are they exempt from the requirement of a business purpose for adopting a tax year for the partnership that differs from its required tax year. File state return only Investing partnership. File state return only   An investing partnership can be excluded if the participants in the joint purchase, retention, sale, or exchange of investment property meet all the following requirements. File state return only They own the property as co-owners. File state return only They reserve the right separately to take or dispose of their shares of any property acquired or retained. File state return only They do not actively conduct business or irrevocably authorize some person acting in a representative capacity to purchase, sell, or exchange the investment property. File state return only Each separate participant can delegate authority to purchase, sell, or exchange his or her share of the investment property for the time being for his or her account, but not for a period of more than a year. File state return only Operating agreement partnership. File state return only   An operating agreement partnership group can be excluded if the participants in the joint production, extraction, or use of property meet all the following requirements. File state return only They own the property as co-owners, either in fee or under lease or other form of contract granting exclusive operating rights. File state return only They reserve the right separately to take in kind or dispose of their shares of any property produced, extracted, or used. File state return only They do not jointly sell services or the property produced or extracted. File state return only Each separate participant can delegate authority to sell his or her share of the property produced or extracted for the time being for his or her account, but not for a period of time in excess of the minimum needs of the industry, and in no event for more than one year. File state return only However, this exclusion does not apply to an unincorporated organization one of whose principal purposes is cycling, manufacturing, or processing for persons who are not members of the organization. File state return only Electing the exclusion. File state return only   An eligible organization that wishes to be excluded from the partnership rules must make the election not later than the time for filing the partnership return for the first tax year for which exclusion is desired. File state return only This filing date includes any extension of time. File state return only See Regulations section 1. File state return only 761-2(b) for the procedures to follow. File state return only Partnership Return (Form 1065) Every partnership that engages in a trade or business or has gross income must file an information return on Form 1065 showing its income, deductions, and other required information. File state return only The partnership return must show the names and addresses of each partner and each partner's distributive share of taxable income. File state return only The return must be signed by a general partner. File state return only If a limited liability company is treated as a partnership, it must file Form 1065 and one of its members must sign the return. File state return only A partnership is not considered to engage in a trade or business, and is not required to file a Form 1065, for any tax year in which it neither receives income nor pays or incurs any expenses treated as deductions or credits for federal income tax purposes. File state return only See the Instructions for Form 1065 for more information about who must file Form 1065. File state return only Partnership Distributions Partnership distributions include the following. File state return only A withdrawal by a partner in anticipation of the current year's earnings. File state return only A distribution of the current year's or prior years' earnings not needed for working capital. File state return only A complete or partial liquidation of a partner's interest. File state return only A distribution to all partners in a complete liquidation of the partnership. File state return only A partnership distribution is not taken into account in determining the partner's distributive share of partnership income or loss. File state return only If any gain or loss from the distribution is recognized by the partner, it must be reported on his or her return for the tax year in which the distribution is received. File state return only Money or property withdrawn by a partner in anticipation of the current year's earnings is treated as a distribution received on the last day of the partnership's tax year. File state return only Effect on partner's basis. File state return only   A partner's adjusted basis in his or her partnership interest is decreased (but not below zero) by the money and adjusted basis of property distributed to the partner. File state return only See Adjusted Basis under Basis of Partner's Interest, later. File state return only Effect on partnership. File state return only   A partnership generally does not recognize any gain or loss because of distributions it makes to partners. File state return only The partnership may be able to elect to adjust the basis of its undistributed property. File state return only Certain distributions treated as a sale or exchange. File state return only   When a partnership distributes the following items, the distribution may be treated as a sale or exchange of property rather than a distribution. File state return only Unrealized receivables or substantially appreciated inventory items distributed in exchange for any part of the partner's interest in other partnership property, including money. File state return only Other property (including money) distributed in exchange for any part of a partner's interest in unrealized receivables or substantially appreciated inventory items. File state return only   See Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. File state return only   This treatment does not apply to the following distributions. File state return only A distribution of property to the partner who contributed the property to the partnership. File state return only Payments made to a retiring partner or successor in interest of a deceased partner that are the partner's distributive share of partnership income or guaranteed payments. File state return only Substantially appreciated inventory items. File state return only   Inventory items of the partnership are considered to have appreciated substantially in value if, at the time of the distribution, their total fair market value is more than 120% of the partnership's adjusted basis for the property. File state return only However, if a principal purpose for acquiring inventory property is to avoid ordinary income treatment by reducing the appreciation to less than 120%, that property is excluded. File state return only Partner's Gain or Loss A partner generally recognizes gain on a partnership distribution only to the extent any money (and marketable securities treated as money) included in the distribution exceeds the adjusted basis of the partner's interest in the partnership. File state return only Any gain recognized is generally treated as capital gain from the sale of the partnership interest on the date of the distribution. File state return only If partnership property (other than marketable securities treated as money) is distributed to a partner, he or she generally does not recognize any gain until the sale or other disposition of the property. File state return only For exceptions to these rules, see Distribution of partner's debt and Net precontribution gain, later. File state return only Also, see Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. File state return only Example. File state return only The adjusted basis of Jo's partnership interest is $14,000. File state return only She receives a distribution of $8,000 cash and land that has an adjusted basis of $2,000 and a fair market value of $3,000. File state return only Because the cash received does not exceed the basis of her partnership interest, Jo does not recognize any gain on the distribution. File state return only Any gain on the land will be recognized when she sells or otherwise disposes of it. File state return only The distribution decreases the adjusted basis of Jo's partnership interest to $4,000 [$14,000 − ($8,000 + $2,000)]. File state return only Marketable securities treated as money. File state return only   Generally, a marketable security distributed to a partner is treated as money in determining whether gain is recognized on the distribution. File state return only This treatment, however, does not generally apply if that partner contributed the security to the partnership or an investment partnership made the distribution to an eligible partner. File state return only   The amount treated as money is the security's fair market value when distributed, reduced (but not below zero) by the excess (if any) of: The partner's distributive share of the gain that would be recognized had the partnership sold all its marketable securities at their fair market value immediately before the transaction resulting in the distribution, over The partner's distributive share of the gain that would be recognized had the partnership sold all such securities it still held after the distribution at the fair market value in (1). File state return only   For more information, including the definition of marketable securities, see section 731(c) of the Internal Revenue Code. File state return only Loss on distribution. File state return only   A partner does not recognize loss on a partnership distribution unless all the following requirements are met. File state return only The adjusted basis of the partner's interest in the partnership exceeds the distribution. File state return only The partner's entire interest in the partnership is liquidated. File state return only The distribution is in money, unrealized receivables, or inventory items. File state return only   There are exceptions to these general rules. File state return only See the following discussions. File state return only Also, see Liquidation at Partner's Retirement or Death under Disposition of Partner's Interest, later. File state return only Distribution of partner's debt. File state return only   If a partnership acquires a partner's debt and extinguishes the debt by distributing it to the partner, the partner will recognize capital gain or loss to the extent the fair market value of the debt differs from the basis of the debt (determined under the rules discussed in Partner's Basis for Distributed Property, later). File state return only   The partner is treated as having satisfied the debt for its fair market value. File state return only If the issue price (adjusted for any premium or discount) of the debt exceeds its fair market value when distributed, the partner may have to include the excess amount in income as canceled debt. File state return only   Similarly, a deduction may be available to a corporate partner if the fair market value of the debt at the time of distribution exceeds its adjusted issue price. File state return only Net precontribution gain. File state return only   A partner generally must recognize gain on the distribution of property (other than money) if the partner contributed appreciated property to the partnership during the 7-year period before the distribution. File state return only   The gain recognized is the lesser of the following amounts. File state return only The excess of: The fair market value of the property received in the distribution, over The adjusted basis of the partner's interest in the partnership immediately before the distribution, reduced (but not below zero) by any money received in the distribution. File state return only The “net precontribution gain” of the partner. File state return only This is the net gain the partner would recognize if all the property contributed by the partner within 7 years of the distribution, and held by the partnership immediately before the distribution, were distributed to another partner, other than a partner who owns more than 50% of the partnership. File state return only For information about the distribution of contributed property to another partner, see Contribution of Property , under Transactions Between Partnership and Partners, later. File state return only   The character of the gain is determined by reference to the character of the net precontribution gain. File state return only This gain is in addition to any gain the partner must recognize if the money distributed is more than his or her basis in the partnership. File state return only For these rules, the term “money” includes marketable securities treated as money, as discussed earlier. File state return only Effect on basis. File state return only   The adjusted basis of the partner's interest in the partnership is increased by any net precontribution gain recognized by the partner. File state return only Other than for purposes of determining the gain, the increase is treated as occurring immediately before the distribution. File state return only See Basis of Partner's Interest , later. File state return only   The partnership must adjust its basis in any property the partner contributed within 7 years of the distribution to reflect any gain that partner recognizes under this rule. File state return only Exceptions. File state return only   Any part of a distribution that is property the partner previously contributed to the partnership is not taken into account in determining the amount of the excess distribution or the partner's net precontribution gain. File state return only For this purpose, the partner's previously contributed property does not include a contributed interest in an entity to the extent its value is due to property contributed to the entity after the interest was contributed to the partnership. File state return only   Recognition of gain under this rule also does not apply to a distribution of unrealized receivables or substantially appreciated inventory items if the distribution is treated as a sale or exchange, as discussed earlier. File state return only Partner's Basis for Distributed Property Unless there is a complete liquidation of a partner's interest, the basis of property (other than money) distributed to the partner by a partnership is its adjusted basis to the partnership immediately before the distribution. File state return only However, the basis of the property to the partner cannot be more than the adjusted basis of his or her interest in the partnership reduced by any money received in the same transaction. File state return only Example 1. File state return only The adjusted basis of Emily's partnership interest is $30,000. File state return only She receives a distribution of property that has an adjusted basis of $20,000 to the partnership and $4,000 in cash. File state return only Her basis for the property is $20,000. File state return only Example 2. File state return only The adjusted basis of Steve's partnership interest is $10,000. File state return only He receives a distribution of $4,000 cash and property that has an adjusted basis to the partnership of $8,000. File state return only His basis for the distributed property is limited to $6,000 ($10,000 − $4,000, the cash he receives). File state return only Complete liquidation of partner's interest. File state return only   The basis of property received in complete liquidation of a partner's interest is the adjusted basis of the partner's interest in the partnership reduced by any money distributed to the partner in the same transaction. File state return only Partner's holding period. File state return only   A partner's holding period for property distributed to the partner includes the period the property was held by the partnership. File state return only If the property was contributed to the partnership by a partner, then the period it was held by that partner is also included. File state return only Basis divided among properties. File state return only   If the basis of property received is the adjusted basis of the partner's interest in the partnership (reduced by money received in the same transaction), it must be divided among the properties distributed to the partner. File state return only For property distributed after August 5, 1997, allocate the basis using the following rules. File state return only Allocate the basis first to unrealized receivables and inventory items included in the distribution by assigning a basis to each item equal to the partnership's adjusted basis in the item immediately before the distribution. File state return only If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. File state return only Allocate any remaining basis to properties other than unrealized receivables and inventory items by assigning a basis to each property equal to the partnership's adjusted basis in the property immediately before the distribution. File state return only If the allocable basis exceeds the total of these assigned bases, increase the assigned bases by the amount of the excess. File state return only If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. File state return only Allocating a basis increase. File state return only   Allocate any basis increase required in rule (2), above, first to properties with unrealized appreciation to the extent of the unrealized appreciation. File state return only If the basis increase is less than the total unrealized appreciation, allocate it among those properties in proportion to their respective amounts of unrealized appreciation. File state return only Allocate any remaining basis increase among all the properties in proportion to their respective fair market values. File state return only Example. File state return only Eun's basis in her partnership interest is $55,000. File state return only In a distribution in liquidation of her entire interest, she receives properties A and B, neither of which is inventory or unrealized receivables. File state return only Property A has an adjusted basis to the partnership of $5,000 and a fair market value of $40,000. File state return only Property B has an adjusted basis to the partnership of $10,000 and a fair market value of $10,000. File state return only To figure her basis in each property, Eun first assigns bases of $5,000 to property A and $10,000 to property B (their adjusted bases to the partnership). File state return only This leaves a $40,000 basis increase (the $55,000 allocable basis minus the $15,000 total of the assigned bases). File state return only She first allocates $35,000 to property A (its unrealized appreciation). File state return only The remaining $5,000 is allocated between the properties based on their fair market values. File state return only $4,000 ($40,000/$50,000) is allocated to property A and $1,000 ($10,000/$50,000) is allocated to property B. File state return only Eun's basis in property A is $44,000 ($5,000 + $35,000 + $4,000) and her basis in property B is $11,000 ($10,000 + $1,000). File state return only Allocating a basis decrease. File state return only   Use the following rules to allocate any basis decrease required in rule (1) or rule (2), earlier. File state return only Allocate the basis decrease first to items with unrealized depreciation to the extent of the unrealized depreciation. File state return only If the basis decrease is less than the total unrealized depreciation, allocate it among those items in proportion to their respective amounts of unrealized depreciation. File state return only Allocate any remaining basis decrease among all the items in proportion to their respective assigned basis amounts (as decreased in (1)). File state return only Example. File state return only Armando's basis in his partnership interest is $20,000. File state return only In a distribution in liquidation of his entire interest, he receives properties C and D, neither of which is inventory or unrealized receivables. File state return only Property C has an adjusted basis to the partnership of $15,000 and a fair market value of $15,000. File state return only Property D has an adjusted basis to the partnership of $15,000 and a fair market value of $5,000. File state return only To figure his basis in each property, Armando first assigns bases of $15,000 to property C and $15,000 to property D (their adjusted bases to the partnership). File state return only This leaves a $10,000 basis decrease (the $30,000 total of the assigned bases minus the $20,000 allocable basis). File state return only He allocates the entire $10,000 to property D (its unrealized depreciation). File state return only Armando's basis in property C is $15,000 and his basis in property D is $5,000 ($15,000 − $10,000). File state return only Distributions before August 6, 1997. File state return only   For property distributed before August 6, 1997, allocate the basis using the following rules. File state return only Allocate the basis first to unrealized receivables and inventory items included in the distribution to the extent of the partnership's adjusted basis in those items. File state return only If the partnership's adjusted basis in those items exceeded the allocable basis, allocate the basis among the items in proportion to their adjusted bases to the partnership. File state return only Allocate any remaining basis to other distributed properties in proportion to their adjusted bases to the partnership. File state return only Partner's interest more than partnership basis. File state return only   If the basis of a partner's interest to be divided in a complete liquidation of the partner's interest is more than the partnership's adjusted basis for the unrealized receivables and inventory items distributed, and if no other property is distributed to which the partner can apply the remaining basis, the partner has a capital loss to the extent of the remaining basis of the partnership interest. File state return only Special adjustment to basis. File state return only   A partner who acquired any part of his or her partnership interest in a sale or exchange or upon the death of another partner may be able to choose a special basis adjustment for property distributed by the partnership. File state return only To choose the special adjustment, the partner must have received the distribution within 2 years after acquiring the partnership interest. File state return only Also, the partnership must not have chosen the optional adjustment to basis when the partner acquired the partnership interest. File state return only   If a partner chooses this special basis adjustment, the partner's basis for the property distributed is the same as it would have been if the partnership had chosen the optional adjustment to basis. File state return only However, this assigned basis is not reduced by any depletion or depreciation that would have been allowed or allowable if the partnership had previously chosen the optional adjustment. File state return only   The choice must be made with the partner's tax return for the year of the distribution if the distribution includes any property subject to depreciation, depletion, or amortization. File state return only If the choice does not have to be made for the distribution year, it must be made with the return for the first year in which the basis of the distributed property is pertinent in determining the partner's income tax. File state return only   A partner choosing this special basis adjustment must attach a statement to his or her tax return that the partner chooses under section 732(d) of the Internal Revenue Code to adjust the basis of property received in a distribution. File state return only The statement must show the computation of the special basis adjustment for the property distributed and list the properties to which the adjustment has been allocated. File state return only Example. File state return only Chin Ho purchased a 25% interest in X partnership for $17,000 cash. File state return only At the time of the purchase, the partnership owned inventory having a basis to the partnership of $14,000 and a fair market value of $16,000. File state return only Thus, $4,000 of the $17,000 he paid was attributable to his share of inventory with a basis to the partnership of $3,500. File state return only Within 2 years after acquiring his interest, Chin Ho withdrew from the partnership and for his entire interest received cash of $1,500, inventory with a basis to the partnership of $3,500, and other property with a basis of $6,000. File state return only The value of the inventory received was 25% of the value of all partnership inventory. File state return only (It is immaterial whether the inventory he received was on hand when he acquired his interest. File state return only ) Since the partnership from which Chin Ho withdrew did not make the optional adjustment to basis, he chose to adjust the basis of the inventory received. File state return only His share of the partnership's basis for the inventory is increased by $500 (25% of the $2,000 difference between the $16,000 fair market value of the inventory and its $14,000 basis to the partnership at the time he acquired his interest). File state return only The adjustment applies only for purposes of determining his new basis in the inventory, and not for purposes of partnership gain or loss on disposition. File state return only The total to be allocated among the properties Chin Ho received in the distribution is $15,500 ($17,000 basis of his interest − $1,500 cash received). File state return only His basis in the inventory items is $4,000 ($3,500 partnership basis + $500 special adjustment). File state return only The remaining $11,500 is allocated to his new basis for the other property he received. File state return only Mandatory adjustment. File state return only   A partner does not always have a choice of making this special adjustment to basis. File state return only The special adjustment to basis must be made for a distribution of property (whether or not within 2 years after the partnership interest was acquired) if all the following conditions existed when the partner received the partnership interest. File state return only The fair market value of all partnership property (other than money) was more than 110% of its adjusted basis to the partnership. File state return only If there had been a liquidation of the partner's interest immediately after it was acquired, an allocation of the basis of that interest under the general rules (discussed earlier under Basis divided among properties) would have decreased the basis of property that could not be depreciated, depleted, or amortized and increased the basis of property that could be. File state return only The optional basis adjustment, if it had been chosen by the partnership, would have changed the partner's basis for the property actually distributed. File state return only Required statement. File state return only   Generally, if a partner chooses a special basis adjustment and notifies the partnership, or if the partnership makes a distribution for which the special basis adjustment is mandatory, the partnership must provide a statement to the partner. File state return only The statement must provide information necessary for the partner to compute the special basis adjustment. File state return only Marketable securities. File state return only   A partner's basis in marketable securities received in a partnership distribution, as determined in the preceding discussions, is increased by any gain recognized by treating the securities as money. File state return only See Marketable securities treated as money under Partner's Gain or Loss, earlier. File state return only The basis increase is allocated among the securities in proportion to their respective amounts of unrealized appreciation before the basis increase. File state return only Transactions Between Partnership and Partners For certain transactions between a partner and his or her partnership, the partner is treated as not being a member of the partnership. File state return only These transactions include the following. File state return only Performing services for, or transferring property to, a partnership if: There is a related allocation and distribution to a partner, and The entire transaction, when viewed together, is properly characterized as occurring between the partnership and a partner not acting in the capacity of a partner. File state return only Transferring money or other property to a partnership if: There is a related transfer of money or other property by the partnership to the contributing partner or another partner, and The transfers together are properly characterized as a sale or exchange of property. File state return only Payments by accrual basis partnership to cash basis partner. File state return only   A partnership that uses an accrual method of accounting cannot deduct any business expense owed to a cash basis partner until the amount is paid. File state return only However, this rule does not apply to guaranteed payments made to a partner, which are generally deductible when accrued. File state return only Guaranteed Payments Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. File state return only A partnership treats guaranteed payments for services, or for the use of capital, as if they were made to a person who is not a partner. File state return only This treatment is for purposes of determining gross income and deductible business expenses only. File state return only For other tax purposes, guaranteed payments are treated as a partner's distributive share of ordinary income. File state return only Guaranteed payments are not subject to income tax withholding. File state return only The partnership generally deducts guaranteed payments on line 10 of Form 1065 as a business expense. File state return only They are also listed on Schedules K and K-1 of the partnership return. File state return only The individual partner reports guaranteed payments on Schedule E (Form 1040) as ordinary income, along with his or her distributive share of the partnership's other ordinary income. File state return only Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenses. File state return only Generally, organizational and syndication expenses are not deductible by the partnership. File state return only However, a partnership can elect to deduct a portion of its organizational expenses and amortize the remaining expenses (see Business start-up and organizational costs in the Instructions for Form 1065). File state return only Organizational expenses (if the election is not made) and syndication expenses paid to partners must be reported on the partners' Schedule K-1 as guaranteed payments. File state return only Minimum payment. File state return only   If a partner is to receive a minimum payment from the partnership, the guaranteed payment is the amount by which the minimum payment is more than the partner's distributive share of the partnership income before taking into account the guaranteed payment. File state return only Example. File state return only Under a partnership agreement, Divya is to receive 30% of the partnership income, but not less than $8,000. File state return only The partnership has net income of $20,000. File state return only Divya's share, without regard to the minimum guarantee, is $6,000 (30% × $20,000). File state return only The guaranteed payment that can be deducted by the partnership is $2,000 ($8,000 − $6,000). File state return only Divya's income from the partnership is $8,000, and the remaining $12,000 of partnership income will be reported by the other partners in proportion to their shares under the partnership agreement. File state return only If the partnership net income had been $30,000, there would have been no guaranteed payment since her share, without regard to the guarantee, would have been greater than the guarantee. File state return only Self-employed health insurance premiums. File state return only   Premiums for health insurance paid by a partnership on behalf of a partner, for services as a partner, are treated as guaranteed payments. File state return only The partnership can deduct the payments as a business expense, and the partner must include them in gross income. File state return only However, if the partnership accounts for insurance paid for a partner as a reduction in distributions to the partner, the partnership cannot deduct the premiums. File state return only   A partner who qualifies can deduct 100% of the health insurance premiums paid by the partnership on his or her behalf as an adjustment to income. File state return only The partner cannot deduct the premiums for any calendar month, or part of a month, in which the partner is eligible to participate in any subsidized health plan maintained by any employer of the partner, the partner's spouse, the partner's dependents, or any children under age 27 who are not dependents. File state return only For more information on the self-employed health insurance deduction, see chapter 6 in Publication 535. File state return only Including payments in partner's income. File state return only   Guaranteed payments are included in income in the partner's tax year in which the partnership's tax year ends. File state return only Example 1. File state return only Under the terms of a partnership agreement, Erica is entitled to a fixed annual payment of $10,000 without regard to the income of the partnership. File state return only Her distributive share of the partnership income is 10%. File state return only The partnership has $50,000 of ordinary income after deducting the guaranteed payment. File state return only She must include ordinary income of $15,000 ($10,000 guaranteed payment + $5,000 ($50,000 × 10%) distributive share) on her individual income tax return for her tax year in which the partnership's tax year ends. File state return only Example 2. File state return only Lamont is a calendar year taxpayer who is a partner in a partnership. File state return only The partnership uses a fiscal year that ended January 31, 2013. File state return only Lamont received guaranteed payments from the partnership from February 1, 2012, until December 31, 2012. File state return only He must include these guaranteed payments in income for 2013 and report them on his 2013 income tax return. File state return only Payments resulting in loss. File state return only   If guaranteed payments to a partner result in a partnership loss in which the partner shares, the partner must report the full amount of the guaranteed payments as ordinary income. File state return only The partner separately takes into account his or her distributive share of the partnership loss, to the extent of the adjusted basis of the partner's partnership interest. File state return only Sale or Exchange of Property Special rules apply to a sale or exchange of property between a partnership and certain persons. File state return only Losses. File state return only   Losses will not be allowed from a sale or exchange of property (other than an interest in the partnership) directly or indirectly between a partnership and a person whose direct or indirect interest in the capital or profits of the partnership is more than 50%. File state return only   If the sale or exchange is between two partnerships in which the same persons directly or indirectly own more than 50% of the capital or profits interests in each partnership, no deduction of a loss is allowed. File state return only   The basis of each partner's interest in the partnership is decreased (but not below zero) by the partner's share of the disallowed loss. File state return only   If the purchaser later sells the property, only the gain realized that is greater than the loss not allowed will be taxable. File state return only If any gain from the sale of the property is not recognized because of this rule, the basis of each partner's interest in the partnership is increased by the partner's share of that gain. File state return only Gains. File state return only   Gains are treated as ordinary income in a sale or exchange of property directly or indirectly between a person and a partnership, or between two partnerships, if both of the following tests are met. File state return only More than 50% of the capital or profits interest in the partnership(s) is directly or indirectly owned by the same person(s). File state return only The property in the hands of the transferee immediately after the transfer is not a capital asset. File state return only Property that is not a capital asset includes accounts receivable, inventory, stock-in-trade, and depreciable or real property used in a trade or business. File state return only More than 50% ownership. File state return only   To determine if there is more than 50% ownership in partnership capital or profits, the following rules apply. File state return only An interest directly or indirectly owned by, or for, a corporation, partnership, estate, or trust is considered to be owned proportionately by, or for, its shareholders, partners, or beneficiaries. File state return only An individual is considered to own the interest directly or indirectly owned by, or for, the individual's family. File state return only For this rule, “family” includes only brothers, sisters, half-brothers, half-sisters, spouses, ancestors, and lineal descendants. File state return only If a person is considered to own an interest using rule (1), that person (the “constructive owner”) is treated as if actually owning that interest when rules (1) and (2) are applied. File state return only However, if a person is considered to own an interest using rule (2), that person is not treated as actually owning that interest in reapplying rule (2) to make another person the constructive owner. File state return only Example. File state return only Individuals A and B and Trust T are equal partners in Partnership ABT. File state return only A's husband, AH, is the sole beneficiary of Trust T. File state return only Trust T's partnership interest will be attributed to AH only for the purpose of further attributing the interest to A. File state return only As a result, A is a more-than-50% partner. File state return only This means that any deduction for losses on transactions between her and ABT will not be allowed, and gain from property that in the hands of the transferee is not a capital asset is treated as ordinary, rather than capital, gain. File state return only More information. File state return only   For more information on these special rules, see Sales and Exchanges Between Related Persons in chapter 2 of Publication 544. File state return only Contribution of Property Usually, neither the partner nor the partnership recognizes a gain or loss when property is contributed to the partnership in exchange for a partnership interest. File state return only This applies whether a partnership is being formed or is already operating. File state return only The partnership's holding period for the property includes the partner's holding period. File state return only The contribution of limited partnership interests in one partnership for limited partnership interests in another partnership qualifies as a tax-free contribution of property to the second partnership if the transaction is made for business purposes. File state return only The exchange is not subject to the rules explained later under Disposition of Partner's Interest. File state return only Disguised sales. File state return only   A contribution of money or other property to the partnership followed by a distribution of different property from the partnership to the partner is treated not as a contribution and distribution, but as a sale of property, if both of the following tests are met. File state return only The distribution would not have been made but for the contribution. File state return only The partner's right to the distribution does not depend on the success of partnership operations. File state return only   All facts and circumstances are considered in determining if the contribution and distribution are more properly characterized as a sale. File state return only However, if the contribution and distribution occur within 2 years of each other, the transfers are presumed to be a sale unless the facts clearly indicate that the transfers are not a sale. File state return only If the contribution and distribution occur more than 2 years apart, the transfers are presumed not to be a sale unless the facts clearly indicate that the transfers are a sale. File state return only Form 8275 required. File state return only   A partner must attach Form 8275, Disclosure Statement, (or other statement) to his or her return if the partner contributes property to a partnership and, within 2 years (before or after the contribution), the partnership transfers money or other consideration to the partner. File state return only For exceptions to this requirement, see section 1. File state return only 707-3(c)(2) of the regulations. File state return only   A partnership must attach Form 8275 (or other statement) to its return if it distributes property to a partner, and, within 2 years (before or after the distribution), the partner transfers money or other consideration to the partnership. File state return only   Form 8275 must include the following information. File state return only A caption identifying the statement as a disclosure under section 707 of the Internal Revenue Code. File state return only A description of the transferred property or money, including its value. File state return only A description of any relevant facts in determining if the transfers are properly viewed as a disguised sale. File state return only See section 1. File state return only 707-3(b)(2) of the regulations for a description of the facts and circumstances considered in determining if the transfers are a disguised sale. File state return only Contribution to partnership treated as investment company. File state return only   Gain is recognized when property is contributed (in exchange for an interest in the partnership) to a partnership that would be treated as an investment company if it were incorporated. File state return only   A partnership is generally treated as an investment company if over 80% of the value of its assets is held for investment and consists of certain readily marketable items. File state return only These items include money, stocks and other equity interests in a corporation, and interests in regulated investment companies and real estate investment trusts. File state return only For more information, see section 351(e)(1) of the Internal Revenue Code and the related regulations. File state return only Whether a partnership is treated as an investment company under this test is ordinarily determined immediately after the transfer of property. File state return only   This rule applies to limited partnerships and general partnerships, regardless of whether they are privately formed or publicly syndicated. File state return only Contribution to foreign partnership. File state return only   A domestic partnership that contributed property after August 5, 1997, to a foreign partnership in exchange for a partnership interest may have to file Form 8865 if either of the following apply. File state return only Immediately after the contribution, the partnership owned, directly or indirectly, at least a 10% interest in the foreign partnership. File state return only The fair market value of the property contributed to the foreign partnership, when added to other contributions of property made to the partnership during the preceding 12-month period, is greater than $100,000. File state return only   The partnership may also have to file Form 8865, even if no contributions are made during the tax year, if it owns a 10% or more interest in a foreign partnership at any time during the year. File state return only See the form instructions for more information. File state return only Basis of contributed property. File state return only   If a partner contributes property to a partnership, the partnership's basis for determining depreciation, depletion, gain, or loss for the property is the same as the partner's adjusted basis for the property when it was contributed, increased by any gain recognized by the partner at the time of contribution. File state return only Allocations to account for built-in gain or loss. File state return only   The fair market value of property at the time it is contributed may be different from the partner's adjusted basis. File state return only The partnership must allocate among the partners any income, deduction, gain, or loss on the property in a manner that will account for the difference. File state return only This rule also applies to contributions of accounts payable and other accrued but unpaid items of a cash basis partner. File state return only   The partnership can use different allocation methods for different items of contributed property. File state return only A single reasonable method must be consistently applied to each item, and the overall method or combination of methods must be reasonable. File state return only See section 1. File state return only 704-3 of the regulations for allocation methods generally considered reasonable. File state return only   If the partnership sells contributed property and recognizes gain or loss, built-in gain or loss is allocated to the contributing partner. File state return only If contributed property is subject to depreciation or other cost recovery, the allocation of deductions for these items takes into account built-in gain or loss on the property. File state return only However, the total depreciation, depletion, gain, or loss allocated to partners cannot be more than the depreciation or depletion allowable to the partnership or the gain or loss realized by the partnership. File state return only Example. File state return only Areta and Sofia formed an equal partnership. File state return only Areta contributed $10,000 in cash to the partnership and Sofia contributed depreciable property with a fair market value of $10,000 and an adjusted basis of $4,000. File state return only The partnership's basis for depreciation is limited to the adjusted basis of the property in Sofia's hands, $4,000. File state return only In effect, Areta purchased an undivided one-half interest in the depreciable property with her contribution of $10,000. File state return only Assuming that the depreciation rate is 10% a year under the General Depreciation System (GDS), she would have been entitled to a depreciation deduction of $500 per year, based on her interest in the partnership, if the adjusted basis of the property equaled its fair market value when contributed. File state return only To simplify this example, the depreciation deductions are determined without regard to any first-year depreciation conventions. File state return only However, since the partnership is allowed only $400 per year of depreciation (10% of $4,000), no more than $400 can be allocated between the partners. File state return only The entire $400 must be allocated to Areta. File state return only Distribution of contributed property to another partner. File state return only   If a partner contributes property to a partnership and the partnership distributes the property to another partner within 7 years of the contribution, the contributing partner must recognize gain or loss on the distribution. File state return only   The recognized gain or loss is the amount the contributing partner would have recognized if the property had been sold for its fair market value when it was distributed. File state return only This amount is the difference between the property's basis and its fair market value at the time of contribution. File state return only The character of the gain or loss will be the same as the character of the gain or loss that would have resulted if the partnership had sold the property to the distributee partner. File state return only Appropriate adjustments must be made to the adjusted basis of the contributing partner's partnership interest and to the adjusted basis of the property distributed to reflect the recognized gain or loss. File state return only Disposition of certain contributed property. File state return only   The following rules determine the character of the partnership's gain or loss on a disposition of certain types of contributed property. File state return only Unrealized receivables. File state return only If the property was an unrealized receivable in the hands of the contributing partner, any gain or loss on its disposition by the partnership is ordinary income or loss. File state return only Unrealized receivables are defined later under Payments for Unrealized Receivables and Inventory Items. File state return only When reading the definition, substitute “partner” for “partnership. File state return only ” Inventory items. File state return only If the property was an inventory item in the hands of the contributing partner, any gain or loss on its disposition by the partnership within 5 years after the contribution is ordinary income or loss. File state return only Inventory items are defined later in Payments for Unrealized Receivables and Inventory Items. File state return only Capital loss property. File state return only If the property was a capital asset in the contributing partner's hands, any loss on its disposition by the partnership within 5 years after the contribution is a capital loss. File state return only The capital loss is limited to the amount by which the partner's adjusted basis for the property exceeded the property's fair market value immediately before the contribution. File state return only Substituted basis property. File state return only If the disposition of any of the property listed in (1), (2), or (3) is a nonrecognition transaction, these rules apply when the recipient of the property disposes of any substituted basis property (other than certain corporate stock) resulting from the transaction. File state return only Contribution of Services A partner can acquire an interest in partnership capital or profits as compensation for services performed or to be performed. File state return only Capital interest. File state return only   A capital interest is an interest that would give the holder a share of the proceeds if the partnership's assets were sold at fair market value and the proceeds were distributed in a complete liquidation of the partnership. File state return only This determination generally is made at the time of receipt of the partnership interest. File state return only The fair market value of such an interest received by a partner as compensation for services must generally be included in the partner's gross income in the first tax year in which the partner can transfer the interest or the interest is not subject to a substantial risk of forfeiture. File state return only The capital interest transferred as compensation for services is subject to the rules for restricted property discussed in Publication 525 under Employee Compensation. File state return only   The fair market value of an interest in partnership capital transferred to a partner as payment for services to the partnership is a guaranteed payment, discussed earlier. File state return only Profits interest. File state return only   A profits interest is a partnership interest other than a capital interest. File state return only If a person receives a profits interest for providing services to, or for the benefit of, a partnership in a partner capacity or in anticipation of being a partner, the receipt of such an interest is not a taxable event for the partner or the partnership. File state return only However, this does not apply in the following situations. File state return only The profits interest relates to a substantially certain and predictable stream of income from partnership assets, such as income from high-quality debt securities or a high-quality net lease. File state return only Within 2 years of receipt, the partner disposes of the profits interest. File state return only The profits interest is a limited partnership interest in a publicly traded partnership. File state return only   A profits interest transferred as compensation for services is not subject to the rules for restricted property that apply to capital interests. File state return only Basis of Partner's Interest The basis of a partnership interest is the money plus the adjusted basis of any property the partner contributed. File state return only If the partner must recognize gain as a result of the contribution, this gain is included in the basis of his or her interest. File state return only Any increase in a partner's individual liabilities because of an assumption of partnership liabilities is considered a contribution of money to the partnership by the partner. File state return only Interest acquired by gift, etc. File state return only   If a partner acquires an interest in a partnership by gift, inheritance, or under any circumstance other than by a contribution of money or property to the partnership, the partner's basis must be determined using the basis rules described in Publication 551. File state return only Adjusted Basis There is a worksheet for adjusting the basis of a partner's interest in the partnership in the Partner's Instructions for Schedule K-1 (Form 1065). File state return only The basis of an interest in a partnership is increased or decreased by certain items. File state return only Increases. File state return only   A partner's basis is increased by the following items. File state return only The partner's additional contributions to the partnership, including an increased share of, or assumption of, partnership liabilities. File state return only The partner's distributive share of taxable and nontaxable partnership income. File state return only The partner's distributive share of the excess of the deductions for depletion over the basis of the depletable property, unless the property is oil or gas wells whose basis has been allocated to partners. File state return only Decreases. File state return only   The partner's basis is decreased (but never below zero) by the following items. File state return only The money (including a decreased share of partnership liabilities or an assumption of the partner's individual liabilities by the partnership) and adjusted basis of property distributed to the partner by the partnership. File state return only The partner's distributive share of the partnership losses (including capital losses). File state return only The partner's distributive share of nondeductible partnership expenses that are not capital expenditures. File state return only This includes the partner's share of any section 179 expenses, even if the partner cannot deduct the entire amount on his or her individual income tax return. File state return only The partner's deduction for depletion for any partnership oil and gas wells, up to the proportionate share of the adjusted basis of the wells allocated to the partner. File state return only Partner's liabilities assumed by partnership. File state return only   If contributed property is subject to a debt or if a partner's liabilities are assumed by the partnership, the basis of that partner's interest is reduced (but not below zero) by the liability assumed by the other partners. File state return only This partner must reduce his or her basis because the assumption of the liability is treated as a distribution of money to that partner. File state return only The other partners' assumption of the liability is treated as a contribution by them of money to the partnership. File state return only See Effect of Partnership Liabilities , later. File state return only Example 1. File state return only Ivan acquired a 20% interest in a partnership by contributing property that had an adjusted basis to him of $8,000 and a $4,000 mortgage. File state return only The partnership assumed payment of the mortgage. File state return only The basis of Ivan's interest is: Adjusted basis of contributed property $8,000 Minus: Part of mortgage assumed by other partners (80% × $4,000) 3,200 Basis of Ivan's partnership interest $4,800 Example 2. File state return only If, in Example 1, the contributed property had a $12,000 mortgage, the basis of Ivan's partnership interest would be zero. File state return only The $1,600 difference between the mortgage assumed by the other partners, $9,600 (80% × $12,000), and his basis of $8,000 would be treated as capital gain from the sale or exchange of a partnership interest. File state return only However, this gain would not increase the basis of his partnership interest. File state return only Book value of partner's interest. File state return only   The adjusted basis of a partner's interest is determined without considering any amount shown in the partnership books as a capital, equity, or similar account. File state return only Example. File state return only Enzo contributes to his partnership property that has an adjusted basis of $400 and a fair market value of $1,000. File state return only His partner contributes $1,000 cash. File state return only While each partner has increased his capital account by $1,000, which will be re