Distributions and taxation - Part 3 - trez_talk - bivio Investment Clubs

Distributions and taxation - Part 3

Rip West on

The Readers always write <g>.

I had said that we would next deal with how to report to the IRS when the amounts you have taken out of the partnership exceed your basis in the club, but there are a number of people who just can't believe that you can take $ 5,000 out of an investment club and not pay tax to Uncle Sam. One such person recently wrote......

Rip, you said.................

CASE 1:

Suppose a member with a basis in the partnership of $10,000 requests a distribution of $5,000. Are you saying that the member pays NO TAX?

And I replied..............

Yes, that's what I'm saying, and more importantly, that's what the IRS is saying <g>

The reader continues.......

I'm trying to follow along with this conversation, but I got lost at this point. If a member makes a partial withdrawal, would he not owe tax on the appreciation that had occurred on whatever portion of his units he sold in order to obtain that distribution? So, his total cost basis in the club is irrelevant, only his cost basis for the shares that he sold.

No, strange as it may seem, that is not the way it works. It is true that when you try to compute how much your partnership interest is worth, you do it by using a unit-based method. But that is only for the purpose of computing your worth. The books are kept on a cost basis, and do not reflect anything about units.

It is an old, established concept of partnership accounting that the investor has an undivided interest in the partnership, the holding period for which starts as of the date that he/she enters the club. The member is allowed to withdraw the amount that he/she has contributed plus any amounts reported as income on the annual k-1's without recognition of income taxes. The fact that units are used to arrive at your net value in the partnership at any time is not material to the IRS.

Therefore, far from the reader's premise being true.............

So, his total cost basis in the club is irrelevant, only his cost basis for the shares that he sold.

The absolute opposite is true. The cost basis for the shares redeemed is irrelevant, and the total cost basis is what is important.

Because you are dealing with an undivided interest, when you do make withdrawals exceeding basis, you do not have to allocate between short-term and long-term gains. Your holding period for the entire gain is calculated from the date that you entered the partnership. The IRS does not know or care that you purchase units each month. They only worry about your taking out more than you put in.

The next article in this series really will deal with how you report your gain to the IRS when your total distributions exceed your tax basis in the partnership.

Rip West
Ridgway, CO
trez_talk@bivio.com

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