Worthless Partnership Interest

[Terry D EA]

Background - Three folks get together and form a partnership and make total contributions of $150,000.00 in 2022. Partnership invests the funds contributed into a venture (another business) with a return structure that looks favorable at the time. (I don't want to give all the details here). No income for 2022 just a loss on some operating expenses. In 2023 the venture goes out of business making the worthless. The partners lose all of their remaining capital. 2023 is the final year for the partnership. The loss experienced by the partnership is the same as the partner total remaining capital.

1. Is this reported as a capital loss by the partnership with the loss passing through to the partners. This method makes the loss a capital loss to the partners and reduces their remaining capital to zero.

2. Because the partners are walking away or abandoning their interest because it is worthless, there are no assets, no debts, none of the partners receive anything that would cause their abandoned interest to be characterized as a capital loss.

Number 2 seems to me the right choice. No sale, no real disposition. Is the partnership required to report this on form 1065? If so, where? The loss to the partners I feel is reported on Sch K-1 line 11 (other income/loss) with code A. I would appreciate some help with this.

[Terry D EA]

I want to add to my post. My initial thoughts was the partnership reports the loss on part II of form 4797. I would think doing so should cause the loss to flow through to the partners k-1 forms at their respective percentages. Again, please confirm.

[Terry D EA]

Are you saying the partners can't report their losses on their tax returns? The partnership cannot return any capital therefore, the partner's should be able to report their loss. Year one partnership experiences 800.00 loss in ordinary income. Their capital accounts are reduced by the loss. 2023 again small loss in ordinary income reduces the capital accounts further. The remainder of each capital account is a loss. 

75,000 cash contribution - 2022 ordinary income loss $400.00 = 74,600.00 remaining capital - 2023 loss $600.00 = 74,000.00 remaining capital. partnership dissolves, partner's have ordinary loss providing no debt, no assets, no return in any form. 

Am I correct?

[DANRVAN]

 

6 hours ago, Terry D EA said:

Three folks get together and form a partnership and make total contributions of $150,000.00 in 2022

It sounds like three partners each contributed $50,000 for total of $150,000.

Partnership invested $150,000 in XYZ Company.   Did they invest capital in another partnership or stock in a corp? 

Either way it appears an investment account should have been recorded as a debit on their books as "Investment in XYZ Company".

Now the investment is worthless so the entry is debit to "loss on investment" and credit to investment account to zero it out.

The result should be a $50,000 capital loss allocated to each partner.

3 hours ago, Terry D EA said:

75,000 cash contribution -

I don't follow, where does $75,000 come from if initial contribution was $150,000 total by three partners?

6 hours ago, Terry D EA said:

partnership reports the loss on part II of form 4797.

Form 4797 is for gain on loss on disposition of business assets.  What you are describing sounds like a capital asset, resulting in a capital loss reported on the K-1s.

 

 

3 hours ago, Terry D EA said:

Year one partnership experiences 800.00 loss in ordinary income

3 hours ago, Terry D EA said:

2022 ordinary income loss $400.00 = 74,600.00 remaining capital - 2023 loss $600.00 = 74,000.00 remaining capital

 

Are there two partners 50/50 instead of three?

Sounds like those losses came from admin. of the original partnership?  Someone kicked in extra cash to pay for them and additional capital?

 

[DANRVAN]

10 minutes ago, DANRVAN said:

Did they invest capital in another partnership or stock in a corp? 

Or something else?

[Terry D EA]

Thanks DANRVAN, I really appreciate your responses. I tried to use figures and information that wasn't directly connected to this client. Sorry for the confusion. The real partnership interest was 50, 25, & 25. The partnership invested into another business that failed miserably, making the partnership interest worthless. This resulted in each partner's interest being worthless as well. I did find a few references in the code specifically section 165a that deals with this very scenario for the partners. Also, a lot of information under Rev. Rul. 93-80; 1993-2 C.B. 239. that includes examples and court cases.

This client's attorney had provided the client with two different scenarios without mentioning any codes or code sections that determine whether the partner's abandoned interest is ordinary or capital loss. For the partnership, section II of form 4797 is to report ordinary gains/loss from business transactions. Drake provided a few check boxes such as abandoned, intangible; etc., that causes the amounts to properly flow to the partner's K-1 and showing the partner's capital account is zero. 

My first approach in my original post was wrong and I did not feel good about it at all for various reasons. 

Edited January 14 by Terry D EA
to add additional content

[Lee B]

I really dislike hypothetical posts because the poster often leaves out important details based on their own preconceived idea of what the answer should be.

[Terry D EA]

Sorry if I offended you. Certainly was not my intention to do so. I only wanted to protect my client. The scenario is not hypothetical just wrong numbers were given and the other information was somewhat vague which I realized later. Anyway, I have it figured out now.

 

[DANRVAN]

On 1/13/2024 at 4:02 PM, Terry D EA said:

invests the funds contributed into a venture (another business)

The relationship between the your client ( a partnership) and this other business is the key in determining whether there was a capital loss or ordinary loss.

If it was another partnership and your client can pass the test to prove it was either worthless or their share was abandoned,  then you will have a case that it was an ordinary loss vs a capital loss.

It appears you are trying say the partners of your clients partnership need to claim their interest is worthless or abandoned to claim a loss.  But that is not the case.

On 1/13/2024 at 7:54 PM, Terry D EA said:

75,000 cash contribution - 2022 ordinary income loss $400.00 = 74,600.00 remaining capital - 2023 loss $600.00 = 74,000.00 remaining capital.

Once the partnership has recognized the loss of the invested $150,000, the 50% partner will have a capital account of -$1,000. (But somebody must have contributed more capital to cover the admin expenses.)

So at this point there is no further loss to claim from worthlessness or abandonment of your clients partnership; since the full loss of each partners contribution has been recognized on their K-1s.

In other words, If the partnership is dissolved nothing is owed to the partners so nothing is lost!

[Terry D EA]

I know you're not asking for clarification but you are correct my client can prove the investment was worthless making it ordinary loss. No remaining basis as the loss is, as you say, is recognized on the partner's K-1's. Biggest thing here is me not explaining everything correctly. 

Thanks,