Outside Basis And Capital Accounts

From the partnership’s side, it receives cash from a partner as a capital contribution and pays the syndication costs, which is capitalized as an intangible asset on the balance sheet.  The question is, what effect does the capital contribution and partnership-level expenditure have on the partner’s basis in its partnership interest and the partnership’s Sec. 704 (b) capital accounts?

In terms of Sec. 722, the partner increases its tax basis in its partnership interest by the amount of capital it is deemed to contribute to the partnership by paying the syndication costs on behalf of the partnership.

In Rev.Rul. 81-153, the IRS confirmed this position.  A partnership that maintains capital accounts per Sec. 704(b) would credit the amount of the supposed contribution to the partner’s capital account.

LP 1 and LP 2 both contribute $1,000 to partnership PRS upon formation, and both receive an equal limit partnership interest.  Both partner’s limited partner’s initial capital account and outside basis in its PRS interest equal $1,000.

GP is a general partner in PRS.

GP incurs $150 of syndication costs on behalf of the partnership.  Immediately, after formation, PRS reimburses GP for the syndication costs incurred. In terms of PRS’s partnership agreement, LP1 and LP2 are entitled to a return of their $1,000 capital contributions before GP is entitled to any distributions.

⇒ GP pays the syndication costs, but it does not bear the economic burden of the costs due to its rights of reimbursement from PRS.

⇒ The reimbursement of the syndication costs incurred by GP deletes PRS’s assets by $150.

⇒ Directly after the reimbursement payments to GP, LP1 and LP2 are both entitled to receive only $925 of their initial capital contributions upon PRS’s liquidation.

⇒ Despite GP’s cash payment to the provider PRS is deemed the payer of the syndication costs.

⇒ The impact of these expenditures must be reflected in the limited partners’ capital accounts.

Careful analysis of the partnership agreement or other relevant documents is necessary to identify the partner who bears the economic burden of the syndication costs paid by or on behalf of a partnership.

The impact on the basis is different from a capital account.  Unlike a capital account, a partner’s basis in its interest is not affected when the partnership is treated as the payer of the syndication costs.

Sec. 705(a)(2)(B) does require a partner to reduce its basis in its partnership interest for its distributive share of nondeductible expenditures, but that impacts only those costs that are not adequately chargeable to capital the capital account. Syndication costs must be capitalized, so partners are not required to reduce their outside basis by their shares of the partnership’s syndication costs.

In terms of Sec. 704(b), the results are different.  Regs. Sec. 1.704-1(b)(2)(iv)(1)(2) treats syndication costs as Sec. 705(a)(2)(B) expenditures for purposes of maintenance of the partnership’s capital accounts.  A partner’s Sec. 704(b) capital account is reduced by its share of a partnership’s syndication costs. Therefore Sec. 704(b) takes into account that the syndication cost as an expenditure of the partnership in the tax year will reduce the amount the partners will receive on liquidation.  The partner who pays the syndication cost will recognize less capital gain (or more capital loss) upon disposition of its interest.  Hence, there is a permanent difference between a partner’s basis in its partnership interest and its Sec. 704(b) capital account equal to the amount of the syndication cost.

Above, each limited partner would still have a basis of $1,000 in partnership interest after taking its share of the $150 syndication cost into account. Each limited partner’s capital account will, however, be reduced to $925.

New Capital Basis requirements For Partnerships: Penalties

The IRS quietly made significant changes to Form 1065, US Return of Partnership Income, effective for the tax year 2020.

⇒ If a partnership reports other than tax basis capital accounts to its partners on Schedule K-1 item L (that is, GAAP, 704(b) book or other), and tax basis capital, if reported on a partner’s Schedule K-1 at the beginning or end of the tax year would be negative, the partnership must report on line 20 of Schedule K-1, using code AH, such partner’s beginning and ending shares of tax basis capital.  This is in addition to the required reporting on item of Schedule K-1.

⇒ For the tax year 2020 any partnerships where GAAP,704(b) or Other is checked in Item L of the Schedule K-1, or any partnership return where tax capital basis is checked (but the tax capital basis was not properly calculated), practitioners are required to report on a partner’s Schedule K-1 for any partner who has negative tax capital basis at the beginning or end of the year. These reporting should be in box 20 on the Schedule K-1 and coded AH.

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