743(b) Adjustment

I just want to make sure I'm understanding the reporting mechanics for the year of adjustment.

For simplicity, let's say we calculate a positive 743(b) adjustment of $100k for a partner and that all of this adjustment is allocable to a 39yr GDS asset.

Unlike 734(b), under 743(b) we don't adjust inside basis of the partnership assets, and the adjustment shouldn't be reflected in the partner's tax capital account?

Therefore, on the return, I would just report 754 depreciation of $2,564 (assuming a whole year) in Box 13W: Section 754 Depreciation/Amortization for the affected partner and that's it? In my basis schedules (excel file, outside the return) I would track the 743(b) adjustment and the annual 754 depreciation?

Also, box 11F (Sec 743(b) positive adjustments) and box 13V (Sec 743(b) negative adjustments) would not come into play here as these boxes relate to positive and negative income adjustments?

Thank you for your time.

Unlike 734(b), under 743(b) we don't adjust inside basis of the partnership assets

Well, you do adjust the inside basis of the assets, but only for the benefit of the purchasing partner.

and the adjustment shouldn't be reflected in the partner's tax capital account?

Correct.

in Box 13W: Section 754 Depreciation/Amortization for the affected partner

No, see below.

In my basis schedules (excel file, outside the return) I would track the 743(b) adjustment and the annual 754 depreciation?

Yes, of course. In addition, in your Excel file, you’ll want to reconcile K1 capital account to true outside basis.

Also, box 11F (Sec 743(b) positive adjustments) and box 13V (Sec 743(b) negative adjustments) would not come into play here as these boxes relate to positive and negative income adjustments?

No, use the 13V, not 13W. This adjustment impacts K1 income (or loss).

You also need to present the unrecovered 743(b) adjustment as of year-end. Box 20, Code AH.

There are also some QBI nuances. On the UBIA side, you need to think this through: Entire building will likely be UBIA…but, it’s been depreciated down. The 743 adjustment will peg off of the adjusted property basis, or we might say, the capital account of the selling partner, which has been diminished by depreciation expense. Thus, the full 743 adjustment will be duplicative to some degree. Example: Pretend 1 partner. Pretend unadjusted building basis is $1m, but adjusted basis is $800k. Selling partner’s capital account is $800k. Your guy buys him out for $1m, so we have a $200k 743 adjustment. Well, your guy will get a K1 with $1m of UBIA showing on it, just based on the partnership’s depreciation schedule. The “U” stands for “Unadjusted.” None of the $200k 743b adjustment represents UBIA because that would be duplicative. In other words, the building hasn’t gone up in value. The 743 adjustment is entirely related to prior depreciation expense in this example. That is, if you show $1.2m of UBIA, that’s not right. The building hasn’t gone up in value since the day it was acquired. Hence the concept of the “Excess” 743 adjustment for QBI/UBIA purposes. Now, if your guy bought selling partner out for $1.1m, that’s another story. Now we really do have new unadjusted basis.

Also not sure why you didn’t post any of the adjustment to Land.

Thanks Jeff. That is helpful.

Well, you do adjust the inside basis of the assets, but only for the benefit of the purchasing partner.

This is what's throwing me for a loop. If the 743(b) adjustment isn't supposed to show up in tax capital, what's the credit of that entry?

Debit Bldg/Land etc
Credit ?

Also not sure why you didn’t post any of the adjustment to Land.

Making the example as simple as possible. There's going to be a split between building and land.

This is what's throwing me for a loop. If the 743(b) adjustment isn't supposed to show up in tax capital, what's the credit of that entry?

There is no entry. One guy bought out the other one external to the partnership. You will (i.e. the partnership will) just maintain a separate depreciation schedule for the 743b adjustment. The assets showing thereon don’t get recorded on the books.

This is what's throwing me for a loop. If the 743(b) adjustment isn't supposed to show up in tax capital, what's the credit of that entry?

There is no entry. One guy bought out the other one external to the partnership. You will (i.e. the partnership will) just maintain a separate depreciation schedule for the 743b adjustment. The assets showing thereon don’t get recorded on the books.

IMO, there are two dynamics here. One, how you record this on their books. Two, how you present this on the tax return.

First, how do you record this on their books?
In QB, for example, I will increase the assets on their books. This helps me to ensure the 743(b) ADJ isn't missed in the future by anyone. As Jeff notes, this, of course, is an asset solely for the benefit of the purchasing partner.

Secondly, how do you present this on the tax return?
There will be a difference between partner capital (both on the K-1 and on Sch M-2) for this 743(b) ADJ asset. The difference will change each year by the amount of the depreciation/amortization of this 743(b) ADJ asset. I've created a couple of worksheets to track this in our WPs. I chose to take this approach as this is the least disruptive in comparison to how we've done it historically.

IMO, there are two dynamics here. One, how you record this on their books. Two, how you present this on the tax return.

Yes, that’s the right way to look at it. It will be up to MVT if he wants to record the basis adjustment on the books, and effectively have a book/tax return difference. To make it real easy to identify things, if you actually did book it up, you could have 1-line item for the assets on the books (i.e. 743b Asset) and a separate line item in the Equity section of the Balance Sheet (i.e. Cap – Frank – 743b). You could post the annual depr expense directly against that capital/equity account. At the end of the day, the debit in the Asset equals the credit in the Equity account. And for that matter, you could even use a separate Equity account instead of a separate Asset account on the books (i.e. call it “Asset – Frank – 743” but set it up as an Equity account in QB’s). This way, the negative in that account washes with the positive in the true 743 Capital account…and these accounts are right next to each in the Equity section of the Balance Sheet (and they wash to $0). That’s probably the easiest way to post things on the books. This way, we’re not messing with assets. Total assets per the books = total assets per Sch L, assuming book equals tax.

Thanks guys.

I get the book side of things. It's a convenient way to keep track of this "thing" that really sits between the partnership and the partner and affects basis.

I think what I'm getting hung up on is the return. So if I report $2,500 of depreciation related to the 743(b) adjustment in Box 13V, this lowers both the partner's taxable income and tax capital account on the return and K-1 by $2,500, even though the 743(b) "book up" was never hit to the tax balance sheet nor capital account. Therefore, theoretically, the partner's capital account could go negative on the K-1 because of this reporting dynamic.

But, I know this is kosher because I know the original 743(b) adjustment, am tracking things, and reconciling to outside tax basis for the partner?

Is that right?

Correct.
I've created a separate worksheet to track "pure" tax capital in addition to the additional "tax capital" a partner has if they have a 743(b) ADJ asset.

I think what I'm getting hung up on is the return. So if I report $2,500 of depreciation related to the 743(b) adjustment in Box 13V, this lowers both the partner's taxable income and tax capital account on the return and K-1 by $2,500

No, not right. It’s also an M1 adjustment.

That's what I was missing...thanks.

The 743(b) adjustment on line 13v does not reduce tax capital. If you are keeping partners' basis, tax basis will equal tax capital + debt + net remaining 743 adjustment. ProFx has a box to check to keep the 743 depreciation from reducing tax capital. Not sure if all software has this.

Drake does not have a box. And it was reducing tax capital by the negative 743(b) adjustment (depreciation). I thought that didn't look right.

An M-1 took care of it.

If you are keeping partners' basis, tax basis will equal tax capital + debt + net remaining 743 adjustment.

And yes, I agree. I conceptualize 743(b) as something that sits between the partnership and the partner.

Where does this go on the M-1? There is no M-1 line for "Deductions on the return that aren't really on the return" is there?

Out of curiosity, what is the harm in booking this up and having it be an actual book and tax deduction? I guess maybe you technically overstating the assets of the partnership using this method?

Where does this go on the M-1? There is no M-1 line for "Deductions on the return that aren't really on the return" is there?

It is on the return. It’s on Schedule K, Line 13. We’ve already gone over that.

Out of curiosity, what is the harm in booking this up and having it be an actual book and tax deduction?

Which allowable method would you be using in that case?

I guess maybe you technically overstating tax assets of the partnership using this method?

I already addressed that point. See the last part of Post #6.

It should not be put on the books, partner capital is used for many different provisions under the partnership rules. If you put an external basis adjustment on the books, you are mis-stating partner capital and that would have a potentially very negative impact to the way allocations and distributions would be interpreted. For example, if you were to put a 743B adjustment on the books that flipped the transferee partner’s capital from being negative to “positive”, what would that mean under the liquidating provisions of the partnership agreement? The books and k-1 would indicate that a partner with negative capital now has positive capital, which is not true, and your return presentation would incorrectly show distributions being made not in accordance with the partnership agreement. I definitely would not put it on the books.

Guaranteed payments, for example are an item that is shown in taxable income on the return, but it is a partner income item, not a partnership income item. K-1 reporting often times includes items that impact a particular partner, and not the partnership in the same way.

For example, if you were to put a 743B adjustment on the books that flipped the transferee partner’s capital from being negative to “positive”, what would that mean under the liquidating provisions of the partnership agreement? The books and k-1 would indicate that a partner with negative capital now has positive capital, which is not true, and your return presentation would incorrectly show distributions being made not in accordance with the partnership agreement. I definitely would not put it on the books.

I have booked 743(b) ADJ on the books of TAX basis partnerships for years and none of what you shared is an actual issue. What it appears your not considering is that the 743(b) asset is a part of the liquidation. That prevents your "issue" from being an issue. The first asset to be distributed in a liquidation is a distribution of the 743(b) asset to the partner to whom it relates. At that point, the issue of distorted economics in a liquidation is off the table.

In the case of a partnership maintaining their books on the 704(b) method, this item wouldn't be recorded.

"Note. Section 743(b) basis adjustments are not taken into account in calculating a partner's capital account under the tax basis method. If section 743(b) adjustments are included in a partner's beginning capital account balance (because they were included in last year's ending capital account), those section 743(b) adjustments, whether positive or negative adjustments, should be removed from the partner's capital account in the 2020 tax year and reported as a 2020 tax year other increase(decrease) item."

From page 32 of 2020 Form 1065 instructions.

I think you can present the balance sheet on a basis other that tax, but then you have issues since the partner capital accounts are new required to be reported on a tax basis, which the IRS has concluded, does not include Sec 743(b) basis adjustments. I have found it easier to just present the balance sheet on the same basis rather than trying to reconcile differences between the balance sheet and the capital accounts on the K-1s.

We’ve had several threads on this issue. All Capt is saying is that he books it up just so he – or a future preparer – doesn’t miss it in the future. And he keeps a spreadsheet that tracks this adjustment and reconciles things out. This is pretty common practice. And note that we now have to report the unrecovered adjustment in Box 20, Code AH:

Other information (code AH). Report the following to each partner. • Attach a statement showing each remaining section 743(b) basis adjustment making up the total and identify the asset to which it relates. Show the section 743(b) adjustment net of any cost recovery to which it relates. A reasonable grouping by asset category may be used, but such grouping should not be less detailed than the asset categories listed on the Schedule L balance sheet. See Section 743(b) positive income adjustments (code F) and Section 743(b) negative income adjustments (code V) earlier. Also see IRS.gov/forms-pubs/ clarifications-for-disregarded-entityreporting-and-section-743b-reporting.

Out of curiosity, what is the harm in booking this up and having it be an actual book and tax deduction?

Which allowable method would you be using in that case?

If we book the 743 on the books and report it on Sch L and M-2 we are not on on true tax inside basis. Ok fine. But say you do it anyway. What is the worst case scenario if the IRS discovers this?

The IRS has also said not to reduce tax basis capital by guaranteed payments. If we do, are we not on tax basis anymore?

Capt, for those tax basis partnership with a 743(b) adjustment on the books, do you keep the adjustment in M-2 balances on the return? If so, are you removing these 743(b) adjustments from partner capital this year?