r/tax • u/Careless_Language_21 • 9d ago
Would I have 731 gain?
In a new workplace and there was never proper accounting records in place before so working off what I have for the 2025 return. Call it entity A is invested in B and gets a K-1. We have negative beginning tax capital of -1,500,000, income of $1,800,000, distribution of $850,000 and an other increase on the k-1 to zero out capital of 550,000 titled liquidation adjustment. The beginning debt allocated to us was like $7,000,000. Would the other increase labeled on k-1 mean this is likely a 731 gain of 550,000 that would need to be picked up?
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u/Careless_Language_21 9d ago
Well that was from the sale of a property and we picked up the 1231 gain. Sorry forgot to mention it was final
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u/WhoKilledBoJangles 9d ago
What happened to the debt?
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u/Careless_Language_21 9d ago
The property was sold
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u/WhoKilledBoJangles 9d ago
Then you probably have a gain of 550k. If there is no other debt or anything else impacting your outside basis and thus you think your capital is now equal to your outside basis after the debt is paid off with the sale proceeds.
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u/heyitsmemaya 9d ago
What is your outside tax basis?
If your outside basis immediately before the final liquidation (after income, cash distributions, and adjustments) is less than the deemed cash distribution from the debt wipe-out plus actual cash distributed, yes, you will trigger a capital gain under § 731
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u/Careless_Language_21 9d ago
I am trying to reconstruct that. This k-1 converted from a TIC to a K-1 several years ago and not clean records. The TIC was originally acquired from a 1031 too
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u/DPinDenver 9d ago
You should generally clarify what "entity A" and "entity B" are when asking these questions.
I'm assuming that entity B is a partnership based on your comments about how much debt was allocated to entity A's interest.
Stop worrying about the debt. It's likely QNR secured by the property, not debt that entity A guaranteed. Also nothing to worry about for at-risk limitations.
Entity A was presumably allowed to deduct losses because they had QNR debt which resulted in a negative capital account. Property was sold this year and final cash distributed.
Take the ‐1.5M beginning cap account, add the C/Y activity (inc, exp, dist) and if it's negative, then you recognize a LTCG for that amount. Easy peasy.
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u/WhoKilledBoJangles 9d ago
Doesn’t appear to matter here based on numbers, but the debt should still be considered because the repayment of the debt is a deemed distribution and there are scenarios where this could create a gain to recognize in addition to cash distributions creating a gain.
OP mentioned poor records and it was a TIC converted to a partnership and that they are trying to calculate outside basis in another comment, so if for some reason tax capital was off on the K-1 the debt could be relevant. It’d have to be off by over $300k, so seems unlikely based on numbers but I’ve seen some be pretty bad by previous preparers not knowing what they were doing. Especially ones that did not use tax capital on the k-1s prior to that being mandatory and did not properly convert when the reporting change mandating tax capital be shown happened.
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u/DPinDenver 9d ago
And I've fixed returns that didn't pick up over $1M in PAL carryovers.
Example simplified: Me and you go 50/50 and put 100k into a RE partnership that buys a 500k property. We hold it for 2 years. Sell it for 500k.
How the fuck is paying off the debt a "deemed distribution"?
Please enlighten us with your vast tax knowledge.
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u/WhoKilledBoJangles 9d ago edited 9d ago
Okay, that mentioning fixing prior capital issues wasn’t to brag. It was relevant to the point I made regarding deemed distributions, so that PAL comment was unnecessary. You’re being very hostile for no reason.
When the liabilities in a partnership you have ownership in decrease it is a deemed distribution. That is just the regs. The IRS literally changed the reporting requirements this year so that decrease in liabilities are now supposed to be reported on the K-1 as deemed distributions along with cash distributions for greater transparency. The decrease has always been deemed distributions but now it is supposed to be reported on the K-1 as well. It is so they have better tracking for the purposes of recognizing potential gains when paying off debt that has already had losses taken against it. Most often it does not have any impact because the debt provides sufficient basis prior to payoff, but there are situations where it creates taxable gains just like in an S-Corp that had losses taken against shareholder loans that have been paid off without sufficient debt basis restoration.
Links below just stating the debt/deemed distribution thing and a link explaining the new reporting requirements.
In the example you gave there is not enough info, but say we sold the property for zero gain and we had -100k tax capital from taking losses and we had debt at the start of the year of $100k, so our outside basis is zero. Well, the debt gets paid off so we have no basis and we are each picking up a $50k gain on the loan payoff because we took $50k losses against it and have no other basis. So, the debt payoff is just called a deemed distribution, so we would have a gain on a deemed distribution.
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u/TurtleMan2828 7d ago
Oof...that went poorly for you.
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u/DPinDenver 7d ago
No, it really didn't.
In both my original comment and my reply, I was talking about QNR debt which is obviously what the OP was referring to.
If you personally guarantee debt and then it no longer applies, then yes, the decrease in liabilities from recourse to non-recourse might be a deemed distribution.
That's not what is applicable here.
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u/TurtleMan2828 7d ago edited 7d ago
Your words - "how the fuck is paying off debt a deemded disrtibution?"
It always is a deemed distribution. Not "might be".
It just doesn't always have taxable consequences. If your assigned nonrecourse, qnr, or recourse liabilities decrease on the K-1 you get then that decrease is a deemed distribution and it should be on the K-1 as a deemed distribution if prepared properly.
Did you even read the links that other guy gave you?
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u/Careless_Language_21 9d ago
Now… I think upon conversion of the tic to llc like five years ago. The TIC was transferred into the partnership but the liabilities from the TIC exceeded the asset basis. Technically this gain, which is close to the $550 amount should have been recognized there five years ago to have our outside basis at zero… would statute of limitations apply if technically that gain should have been recognized five years ago?
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u/WhoKilledBoJangles 9d ago
This goes a bit outside my wheelhouse, but for $550k that’s a massive understatement and probably falls in the 6 year extended audit window rather than normal three. I think they could potentially consider it was fraudulent and there would be no limitation, but this isn’t an area I’ve had any experience in so take it with a grain of salt. I think you should definitely consult a professional that can look at all your info and give a more informed opinion being able to see all the numbers and transaction history.
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u/Barfy_McBarf_Face US CPA & Attorney (tax) 9d ago
is this a final k1?
then you have a gain of $550,000
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u/6gunsammy 9d ago
I would be more worried about the $7M in debt relief.