Does it Pay NOT to Claim Deductions?

Rip West on

It's that time of year again, and here is a question that keeps cropping up.

Since there is a limitation on deductibility of investment expenses, none of our partners will benefit by taking this deduction. Yet the tax basis of each partner's interest in the partnership will be decreased by the unallowed deduction. Wouldn't it be better not to take the deduction at all?

There is a fallacy in the above argument which is not apparent at first blush. Let's compare two examples. To keep it simple, consider that I am a partnership of one member. First assume, that I have a tax basis for my partnership interest of $1,000. Now assume that the partnership incurs an expense of $100. The club will receive a deduction of $100, which will be passed through to me, and my basis in the partnership will be reduced to $900. Because of the limitation on deductibility of investment expenses, I am unable to take advantage of the $100 investment expense passed through to me.

Result: My basis in the partnership is now $900, and I have received no benefit from the $100 expenditure.

Now, let's take the same example. I have a tax basis in the partnership of $1,000. The bill for the $100 expense comes due. I choose not to deduct this expense so that my basis will not be diminished. I could pay it personally. Then I have paid in $1,100 [$1,000 for the partnership interest and $100 for the expense].

Result: My basis in the partnership is now $1,000. I have received no benefit from the $100 expenditure, but I have paid a total of $1,100. I could take a partial withdrawal from the club for $100, and my basis would be $900, and I would be in exactly the same position as the first example, proving, I hope, that there is no advantage to NOT taking a deduction.

Note that bivio now has the ability to record non-deductible expenses. Note, also, that this would result in the same non-benefit to the partners as the above examples.

Therefore, I still recommend that the club take all legitimate deductions, regardless of whether or not the members will be able to use them on their individual 1040's.

Rip West
Saint Paul, MN
trez_talk@bivio.com

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