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Increasing or decreasing partnership interest basis through operations

By paying the tax you get the benefit of the income by increasing your basis in the partnership

Our recent blog looked at what you need to know about equipment basis. Here we will look at your basis in a partnership – and let me start by saying, it’s a little more complicated.

I’ll go over some of the basics but the best advice I can give you is to talk to your CPA when you’re thinking about getting into a partnership or S-Corp. Whether it’s a brand-new partnership you and brother are starting or buying into a partnership that your dad and his brothers started, there are a lot of nuances to partnerships that I cannot get into here. Talk to your CPA and don’t spare any details.

When you are in a partnership, you get taxed on your allocable share of net income. You pay the taxes because partnerships are pass-through entities in the eyes of the IRS; any income or losses “pass-through” the entity and are handled by the owners. So remember when we talked about thinking of tax basis as, “what did it cost me?”

Generally, you think that, “since I got the income, I need to pay the tax.” You don’t get a check for that amount of net income so why would you pay tax on it?

Since “income = tax” is true, then “tax = income” is also true. By paying the tax, you get the benefit of the income by increasing your basis in the partnership. You are keeping the money in the business so your interest in the business should reflect that. The net income increases your basis in the partnership and now your partnership interest is worth more. When – or if – you sell your interest, you get to deduct your basis from your selling price because you already paid the taxes on that income.

Distribution checks

For those of you already in a farming partnership, you may get distribution checks to help pay the tax on the income. Those distribution checks decrease your basis because it’s money the partnership is giving you out of your share of the income that was allocated to your basis.

Here is a quick overview of events that will effect partnership basis:

Partnership Interest Basis

Though we did not go over debt in the body of the article, it is an important part of your business strategy and will also affect basis. There are some nuances with debt that need more space to discuss so we will get into the effect of debt on partnership interest in a later article.

Please keep in mind that this is not a complete list of transactions that affect basis. A lot of other transactions – including buying and selling interest of an existing partnership – will affect your basis as well. We will come back to this topic later but be sure to talk to your CPA on partnerships if you are thinking about getting into one.

The opinions of the author are not necessarily those of Farm Futures or Farm Progress. 

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