1. To what extent is a partner allowed to take into account its distributive share of partnership losses?
Section 704(d) of the Code provides, in general, that a partner’s distributive share of partnership loss (including capital loss) is allowed only to the extent of the adjusted basis of such partner’s interest in the partnership (outside basis) at the end of the partnership year in which such loss occurred. If, in a given taxable year, a partner’s share of partnership losses exceeds its outside basis, then the losses are allowed to the extent of basis and any excess amount is carried over for use in the next taxable year in which the partner has outside basis available. Except for deductions relating to charitable contributions and foreign taxes, current law and prior law are the same.
Jen and Dave are equal partners in JD Partnership. At the end of the partnership taxable year, but prior to taking into account the partnership’s income and loss items, Jen and Dave each have a $50 basis in the JD partnership. For the taxable year the JD partnership has $20 of non-separately stated taxable income and a $150 long-term capital loss.
To determine each partner’s basis limitation under §704(d), Jen and Dave increase their outside bases from $50 to $60 under § 705(a)(1) for their $10 distributive shares of the partnership’s non-separately stated income. Their $75 shares of long-term capital loss are limited by §704(d) and, as a result, Jen and Dave can each take $60 of the loss into account in the current taxable year. The remaining $15 of long-term capital loss is carried forward. This result is the same under current and prior law.
2. Under prior law, was a partner’s share of charitable contributions made by, or foreign taxes paid by, the partnership subject to § 704(d) basis limitation?
No, under prior law a partner’s share of a partnership’s charitable contributions and foreign tax payments were not subject to the § 704(d) basis limitation. This meant that partners could take into account their entire distributive shares of charitable contributions or foreign tax payments even if they were in excess of outside basis. Although a portion of certain charitable contributions and the entire amount attributable to foreign tax payments were (and still are) subject to basis reduction under § 705(a)(2), prior law did not limit a partner’s deductions for payments in excess of basis.
Assume the same facts as in Example 1, except that, at the end of the partnership taxable year (and before partnership allocations), Jen’s outside basis is $50 and Dave’s is $30. For the taxable year, the partnership makes a contribution to a § 501(c)(3) charity of property that has a fair market value of $300 and a basis of $100, but has no other items of income, gain, loss, or deduction.
Under prior law, Jen and Dave each would have been able to take into account (on their personal returns) their $150 shares of the charitable contribution. Jen would have been required to decrease her outside basis by $50 (her share of the partnership’s basis in the property) to zero ($50-$50=0). However, because Dave only has $30 of outside basis, any basis reduction would have been limited to $30 because outside basis cannot be decreased below zero. Therefore, under prior law, Jen would have had to decrease her outside basis by $50 to receive the benefit the entire $150 contribution deduction whereas Dave only would have had to decrease his outside basis by $30 to receive the same $150 benefit.
3. How did the TCJA change the rules for determining losses subject to the basis limitation?
The TCJA adds new § 704(d)(3)(A). That section provides that charitable contributions and foreign taxes are taken into account under the basis limitation rules, thereby putting those items on par with other losses and, as a result, limiting the benefit of such items by a partner’s outside basis. However, new § 704(d)(3)(B) provides that, in the case of a charitable contribution of built-in gain property (i.e., property whose fair market value exceeds its adjusted basis), the excess amount is not limited by outside basis. These changes apply to partnership taxable years beginning after December 31, 2017. This new rule means that, for charitable contributions of appreciated property, the amount allocable to the partners will effectively be split into two parts, one equaling the property’s built-in-gain amount, the other the property’s basis. The deduction for the built-in gain portion neither reduces the partner’s bases nor is subject to limitation under section 704(d) (as under prior law). However, the part reflecting the property’s basis is limited by section 704(d).
Assume the same facts as in Example 2, except that the partnership makes the contribution of appreciated property to charity in a taxable year of the partnership beginning after December 31, 2017.
Under the new law, the portion of the contribution that is equal to the property’s basis ($100) both reduces the partner’s outside bases and is subject to section 704(d). The excess portion neither reduces outside basis nor is subject to section 704(d). Jen, whose outside basis is $50, would reduce her outside basis by $50 (her share of the basis of the contributed property) and receive a charitable contribution allocation of $150. For Dave, whose outside basis is $30, the basis reduction and charitable contribution with respect to the basis portion of the contribution would be limited to $30. The $20 excess would carry over to the following year. Dave’s total charitable contribution would be $130.