Section 1061 Reporting Guidance FAQs

 

Purpose of Reporting Guidance

Section 1061 was added to the Internal Revenue Code as part of the Tax Cuts and Jobs Act (TCJA). For taxable years beginning after December 31, 2017, section 1061 recharacterizes certain net long-term capital gains of a partner that holds one or more applicable partnership interests as short-term capital gains. The provision generally requires that a capital asset be held for more than three years for capital gain allocated with respect to any applicable partnership interest (API) to be treated as long-term capital gain. Proposed regulations (REG-107213-18) were published in the Federal Register on August 14, 2020. Final regulations (TD 9945) were published in the Federal Register on January 19, 2021. Owner Taxpayers and Passthrough Entities may rely on the proposed regulations for taxable years beginning before January 19, 2021 (the date final regulations were published in the Federal Register), provided they follow the proposed regulations in their entirety and in a consistent manner. An Owner Taxpayer or a Passthrough Entity may choose to apply the final regulations to a taxable year beginning after December 31, 2017, provided that it consistently applies the final section 1061 regulations in their entirety to that year and all subsequent years. Owner Taxpayers and Passthrough Entities must apply the final regulations to taxable years beginning on or after January 19, 2021 (the date final regulations were published in the Federal Register).

The purpose of the FAQs is to provide Passthrough Entity filing requirements and reporting, and Owner Taxpayer filing requirements in accordance with Treas. Reg. section 1.1061-6. See TD 9945 for specific rules, including the definitions of capitalized terms used in these FAQs.

1. What information does a Passthrough Entity need to report to its API Holders? (added November 3, 2021)

A Passthrough Entity is required to attach Worksheet A PDF to the API Holder's Schedule K-1 for tax returns filed after December 31, 2021 in which a Passthrough Entity applies the final regulations under TD 9945. A Passthrough Entity means a partnership, trust, estate, S corporation described in section 1.1061-3(b)(2)(i), or a passive foreign investment company described in section 1.1061-3(b)(2)(ii). The Passthrough Entity must provide the information in Worksheet A to each API Holder, including an Owner Taxpayer, as an attachment to the Schedule K-1 for the applicable form, notating the proper box and code. For the Form 1065, U.S. Return of Partnership Income, it is box 20, code AH. For the Form 1120S, U.S. Income Tax Return for an S Corporation, it is box 17, code AD. For the Form 1041, U.S. Income Tax Return for Estates and Trusts, it is box 14, code Z.

See section 1.1061-6(c) for the section 1061 reporting rules of a regulated investment company (RIC) and a real estate investment trust (REIT). In the case of RICs and REITs the information will be furnished in connection with the Form 1099-DIV, Dividends and Distributions.

Section 1.1061-6(d) permits a passive foreign investment company (PFIC) with respect to which the shareholder is an API Holder who has a qualified electing fund election (as described in section 1295(a)) in effect for the taxable year to provide additional information to the shareholder to determine the amount of the shareholder's inclusion that would be included in the API One Year Distributive Share Amount and the API Three Year Distributive Share Amount. If the PFIC furnishes this information to the shareholder, the shareholder must retain a copy of this information along with the other information required to be retained under section 1.1295-1(f)(2)(ii).

A Passthrough Entity that is not required to and does not choose to apply the final regulations to tax returns filed after December 31, 2021 for a taxable year beginning before January 19, 2021, must attach a worksheet to the API Holder's Schedule K-1 that contains similar information as Worksheet A PDF, and must disclose whether the information was determined under the proposed regulations or another method.

Calculation and Reporting for the API One Year Distributive Share Amount and API Three Year Distributive Share Amount by a Passthrough Entity

2. How does an Owner Taxpayer calculate the amount that is treated as short-term capital gain under section 1061? (added November 3, 2021)

An Owner Taxpayer is the person who is subject to Federal income tax on the Recharacterization Amount, and could be an individual, estate, or trust. An Owner Taxpayer uses the information provided by all the Passthrough Entities in which it holds an API, directly or indirectly, to determine the amount that is recharacterized as short-term capital gain under section 1061(a) and (d) for a taxable year. For tax returns filed after December 31, 2021 in which the Owner Taxpayer applies the final regulations under TD 9945, Worksheet B PDF must be used to determine the amount of the Owner Taxpayer's Recharacterization Amount. Worksheet B, along with Tables 1 PDF and 2 PDF are to be attached to the Owner Taxpayer's tax return.

An Owner Taxpayer that is not required to and does not choose to apply the final regulations to tax returns filed after December 31, 2021 for a taxable year beginning before January 19, 2021, must attach worksheets to its return that contain similar information as Worksheet B PDF and Tables 1 PDF and Table 2 PDF, and must disclose whether the information was determined under the proposed regulations or another method.

Calculation and Reporting of Recharacterization Amount by the Owner Taxpayer

3. After calculating the Recharacterization Amount, how does an Owner Taxpayer properly report amounts on Schedule D (Form 1040 and Form 1041) and on Form 8949? (added November 3, 2021)

An Owner Taxpayer includes long-term and short-term API Gains and Losses on Schedule D (Form 1040 and Form 1041) and on Form 8949, Sales and Other Dispositions of Capital Assets, as if section 1061 does not apply. In addition, if the Owner Taxpayer has a Recharacterization Amount as computed in line 7 of Worksheet B, and/or any amounts resulting from the application of section 1061(d) (transfer of an API to a related person) in line 8 of Worksheet B (see section 1.1061-5(c)), the Owner Taxpayer will increase the reported short-term capital gain by listing as a transaction identified as "Section 1061 Adjustment" on Form 8949, Part I, line 1, column (a) and entering the amount from line 9 of Worksheet B as proceeds (column (d) of the Form 8949) and zero as basis (column (e) of the Form 8949). The Owner Taxpayer will make corresponding entries on Form 8949, Part II, line 1, to reduce the reported long-term capital gain by listing as a transaction identified as "Section 1061 Adjustment" in column (a) of the Form 8949 and entering zero as proceeds (column (d) of the Form 8949) and the amount from line 9 of Worksheet B as basis (column (e) of the Form 8949).

4. How does the Owner Taxpayer report collectibles gain and unrecaptured section 1250 gain? (added November 3, 2021)

Pending further guidance, if the Owner Taxpayer sells an API and recognizes collectibles gain or loss or unrecaptured section 1250 gain, or if a Passthrough Entity reports that collectibles gain or loss or unrecaptured section 1250 gain is treated as API Gain or Loss, the Owner Taxpayer must use a reasonable method to compute the amount of the inclusion of collectibles gain and/or unrecaptured section 1250 gain in the Recharacterization Amount that is calculated in Worksheet B.

If the Owner Taxpayer has received an API One Year Distributive Share Amount and an API Three Year Distributive Share Amount that includes collectibles gain or loss and/or unrecaptured section 1250 gain from a Passthrough Entity, the Owner Taxpayer should include those amounts on lines 1 and 4, respectively, of Worksheet B.

On line 10 of Worksheet B, the Owner Taxpayer must report the total amount of collectibles gains for the taxable year that the Owner Taxpayer has with respect to any interest in a Passthrough Entity (Passthrough Interests) that it owns. It must also report the amount of collectibles gain that is recharacterized as short-term capital gain under section 1061 and the amount of collectibles gain that is not recharacterized and that is included in the 28% Rate Gain Worksheet (see line 18 of the Schedule D (Form 1040), or line 18c of the Schedule D (Form 1041)). Collectibles gain or loss that is API Gain or Loss and is included in the calculation of the Recharacterization Amount, but not recharacterized, must be included in the 28% Rate Gain Worksheet. Collectibles gain or loss with respect to a Passthrough Interest that it is treated as Capital Interest Gain or Loss must also be included in the 28% Rate Gain Worksheet.

Similarly, on line 11 of Worksheet B, the Owner Taxpayer must report the total amount of unrecaptured section 1250 gain for the taxable year that the Owner Taxpayer has with respect to any Passthrough Interests that it owns. It must also report the amount of unrecaptured section 1250 gain that is recharacterized as short-term capital gain under section 1061 and the amount of unrecaptured section 1250 gain that is not recharacterized and that is included in the Unrecaptured Section 1250 Gain Worksheet (see line 19 of the Schedule D (Form 1040), or line 18b of the Schedule D (Form 1041)). Unrecaptured section 1250 gain or loss that is API Gain or Loss and is included in the calculation of the Recharacterization Amount, but not recharacterized, must be included in the Unrecaptured Section 1250 Gain Worksheet. Unrecaptured section 1250 gain or loss with respect to a Passthrough Interest that is treated as Capital Interest gain or loss must also be included in the Unrecaptured section 1250 Gain Worksheet.

Reporting Example for Worksheets A and B.

Owner Taxpayer M, an individual, holds an API in XYZ partnership and receives a Schedule K-1 with Worksheet A attached from XYZ partnership for the tax year 2021, that contains a long-term capital gain of $55,000 on box 9a of the Schedule K-1. Taxpayer M did not dispose of an API in 2021. The following is a summary of Worksheet A that XYZ partnership attached to Taxpayer M's Schedule K-1: Line 4 has an API One Year Distributive Share Amount of $55,000 and line 7 has an API Three Year Distributive Share Amount of $20,000.

Taxpayer M reports a $55,000 long-term capital gain from XYZ partnership on Schedule D (Form 1040), line 12. Taxpayer M chose to follow the final regulations under TD 9945 in preparation of his 2021 tax return and prepares and attaches Worksheet B to his Form 1040. Worksheet B has a One Year Gain Amount on line 3 of $55,000, a Three Year Gain Amount of $20,000 on line 6, a Recharacterization Amount on line 7 of $35,000, a Section 1061 Adjustment on line 9 of $35,000. In addition to reporting the long-term capital gain of $55,000 on Schedule D (Form 1040), line 12, Taxpayer M reports on Form 8949, Part I, line 1, a short-term capital gain of $35,000, and on Part II, line 1, long-term capital loss of ($35,000). Both Form 8949 items are described in column (a) as "Section 1061 Adjustment."