Yes and No. Normally, the losses of a limited partnership are passed directly to the limited partners who can use the losses to offset other passive income. If they have more passive losses than passive income, the losses can be carried forward.
When a partner or an individual receives a Schedule K – 1 from a partnership reflecting a loss, there are many factors to consider before deciding if the loss can be deducted. In order to determine deductibility, a partner’s basis and at risk limitations need to be evaluated.
Factors That Determine Tax Deductions for a Limited Partnership
First, note that a partner is expected to have adequate basis in the partnership to qualify or consider the deductibility of the partnership loss. A taxpayer’s tax basis in a partnership interest (often called the partner’s outside basis) more or less represents the partner’s cost for tax purposes and is used to measure the taxable gain or loss upon disposition of the partnership interest.
Also, a partner’s tax basis can (1) limit the partner’s ability to deduct a partnership loss; (2) cause a cash distribution to be taxable instead of tax – free; and (3) affect the basis of property received as a distribution. However, a partner’s initial basis equals the amount of money contributed, plus the adjusted basis of property contributed, plus the partner’s share of the partnership’s liabilities.
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Types of Liabilities of a Partnership
Note that all the liabilities of the partnership are more or less classified into three categories. First is recourse debt, which is simply the debt that a partner is tasked with paying back if there is an economic risk of loss on the debt, such as security deposits and loans made by partners to the partnership.
The second category is nonrecourse debt, which is also the debt a partner is not liable to repay if the entity cannot. And the last type of liability is qualified non – recourse debt, such as a mortgage held by a financial institution. Howbeit, all three types of liabilities are allocated to the partners in the same proportion as the profit and loss allocation, except for recourse debt, which is allocated based on whoever bears the risk of economic loss.
Also note that the IRS generally does not allow limited partners to deduct losses related to passive activities, except to the extent that those losses can offset other income from passive activities. The IRS considers passive activities to be “trade or business activities in which you did not materially participate.”
Generally, if you are not involved in the management of a limited partnership, it is a passive activity. Almost all rental activities are considered passive, although exceptions exist that allow low-income taxpayers to deduct a limited amount of losses related to rental activities.
Also have it in mind that deductible losses are reported by the individual limited partners to the IRS on Schedule E of Form 1040, U.S. Individual Income Tax Return. These losses are then used to reduce income from all other sources. When losses are not deductible, the limited partner must separately track the limitation.
Additionally, losses limited by basis become deductible when the limited partner achieves sufficient basis and losses limited as passive activities become deductible when the limited partner recognizes other passive income or the activity generating the losses is sold.
Indeed, losses and deductibles in a limited partnership is a very complex area, and navigating the rules should be done in coordinated consultations with an attorney and a tax advisor. It is always advisable you consult with a tax advisor to discuss your liabilities to ensure your basis and at risk limitations are being properly reported.
Tax Deduction Benefits of a Limited Partnership
In the U.S., a limited partnership is a business entity formed under state limited partnership laws. Limited partners are more or less investors whose personal liability in a business entity is limited to the amount of capital contributed, or required to be contributed, to the business entity.
1. Capital Loss
In the United States, the IRS does not tax a limited partnership directly. Owing to this, limited partnerships do not face double taxation–that is, the taxation of a business, as well as the individual business owners.
Also note that the pass – through or flow – through taxation entails that the partners of the limited partnership pay only the capital gains tax applied to individual investors, which varies based on how much the partner has earned in the business. And since profits reflect capital gains tax laws, so do losses; and each partner can easily write off her capital losses on the personal tax statement.
Although the limited partnership does not enjoy the same business standing of an organization such as limited liability corporations, the limited partnership is still a business and can also buy property and vehicles as a business. Also note that depreciation occurs from the items that are acquired and they tend to lose value over time from their original value.
A perfect example of depreciation is a vehicle, because, as the saying goes, it loses value the moment it is driven off the lot. If the limited partnership keeps the vehicle over several years, the partners are allowed to deduct the amount that the vehicle depreciates each year.
3. Operation Expense
Also note that any operational expenses that the partners must put out for the maintenance of the business can be deducted on tax statements. These operational expenses include internet costs for running online businesses and health care costs for each partner in the limited partnership. In addition, tax deductions can also include the sales tax paid for a brand new vehicle (just for the year purchased) and payments for energy – savings options added to the business location.
Limited partnerships that take out loans of almost any variety can write off expenses from interest payments. Have it in mind that borrowed money can make money in a business, but the interest payments can also create the appearance of great loss, particularly for larger loans. Howbeit, the partners of the limited partnership can write off the interest payments as a necessary business expense.
The main items that generate tax write – offs in the limited partnership are interest expenses, operating and maintenance expenses, depreciation or depletion, and tax credits. Limited partnerships are expected to file Form 1065, U.S. Return of Partnership Income, with the Internal Revenue Service.
Form 1065 lists all income and deductions of the partnership and allocates the income and deductions to the general and limited partners. Limited Partners will receive a Schedule K – 1 from the partnership, which reports to them their share of income and deductions from the partnership. A copy of the Schedule K – 1 is also sent by the partnership directly to the IRS.