Hi, I would appreciate help with the tax ramifications for a Partners Profits in a Limited Partnership?
Let's assume that the partner contributes (a NYSE traded) stock that he purchased for $1,000 which I believe means that his cost basis in the LP is $1,000.
Now let’s say the stock appreciates over the time and it is worth $10,000, and the Limited Partnership sells the stock for $10,000.
The CapGain on the sale would be $9,000 (sale price - purchase price) and since the Partners cost basis is $1,000, I believe that he can withdraw (his cost basis) $1,000.
But the LP has a profit of $9K (sales price - original $1,000 = $9,000 profit/income), that will be calculated on Form 1065 and “passed-through” to his Form 1040 via the K-1 and he will pay CapGains tax of the $9,000 profit.
So in essence, he will need to pay CapGain tax on $9,000 but he can only withdraw $1,000 (which is the balance of his cost basis in the LP)?
What happened to the $9,000 that is the LP has as a profit?
Does he every have access to the $9,000?
I’m afraid to ask because you might tell me if he withdraw the $9,000, he will have to pay Ordinary Income tax on the $9,000 or DOUBLE TAXATION.
I would appreciate if you can help me understand the tax ramifications of this scenario.
Thank you for your help,
Bob

“But the LP has a profit of $9K (sales price - original $1,000 = $9,000 profit/income), that will be calculated on Form 1065 and “passed-through” to his Form 1040 via the K-1 and he will pay CapGains tax of the $9,000 profit.”--> Agreed.
“So in essence, he will need to pay CapGain tax on $9,000 but he can only withdraw $1,000 (which is the balance of his cost basis in the LP)??--->In general correct. However, it depends on the LP’s marginal tax rate as said below; the LP’s original basis is increased by $1,000 by the the partner's stock contribution to the partnership. However, as the LP withdraws his basis, $1,000, the partner's basis is decreased to zero(but never below zero).
“ What happened to the $9,000 that is the LP has as a profit? Does he every have access to the $9,000?”--->I guess so;the LP reports $9,000, assume that it is LTCG, on 1065 line 9a and on Schedule D (Form 1040), line 12 & 15.The LP also needs to report the amount from line 16 of Sch D on Form 1040, line 13 and then , I guess, need to complete the “Qualified Dividends and Capital Gain Tax Worksheet” to calculate the LP’s LTCG tax on 1040 line 44. The LP’s LTCG tax liability is determined , depending on his marginal tax rate; for example, if his tax bracket is lower than 25%, then he pays $0 on the LTCG, $9,000, in 2011. If his marginal tax rate is 25% or higher than 25%, then his LTCG tax liability‘d be $1,350; $9,000*15%=$1,350.
Please visit the Website here; Capital gains tax in the United States - Wikipedia, the free encyclopedia
http://www.irs.gov/app/vita/content/...heet_1040i.pdf
“I’m afraid to ask because you might tell me if he withdraw the $9,000, he will have to pay Ordinary Income tax on the $9,000 or DOUBLE TAXATION.”---> No, I don’t think so. The profits of a partnership pass through to its owners, who report their share on their individual tax returns. Therefore, the profits are only taxed once (at the personal level of its owners) rather than twice. As said above, his profit, $9,000, LTCG, is NOT subject to double taxation. The profit is LTCG , NOT ordinary gain. A limited partner is akin to a shareholder in a corporation. Because the sale of the LP’s interest involves the sale of his stock, it is subject to state and federal laws dealing with the sale of securities and, unless exempt, must be registered with the SEC and the appropriate state securities authorities.

Thank you so much for your reply Wnhough, this is rather complicated (at least it is for me) and I really appreciate you helping me understand it.
If you don't mind, I would like to ask some follow-up questions and to try and avoid confusion (or may be it will add to the confusion), I am enclosing your reply below and have put into Italics that items that are not in question and high-lited in BOLD, those that I have follow-up questions and my "new questions" are in BLUE

[SIZE="2"]But the LP has a profit of $9K (sales price - original $1,000 = $9,000 profit/income), that will be calculated on Form 1065 and “passed-through” to his Form 1040 via the K-1 and he will pay CapGains tax of the $9,000 profit.”--> Agreed.[/size]
“So in essence, he will need to pay CapGain tax on $9,000 but he can only withdraw $1,000 (which is the balance of his cost basis in the LP)??--->In general correct. However, it depends on the LP’s marginal tax rate as said below;
I don't believe that the Limited Partnership PAYS tax! I thought that the LP prepares a Form 1065 with accompanying K-1s, which are then sent to the Partners and incorporated in the Patrners (1040) Tax Return? So I am not sure what you mean by the LP Marginal Tax Rate



the LP’s original basis is increased by $1,000 by the the partner's stock contribution to the partnership. However, as the LP withdraws his basis, $1,000, the partner's basis is decreased to zero(but never below zero). Understand


“What happened to the $9,000 that is the LP has as a profit? Does he every have access to the $9,000?”---> I guess so;the LP reports $9,000, assume that it is LTCG, on 1065 line 9a and on Schedule D (Form 1040), line 12 & 15.
May be it's just semantics, I understand that LP reports the LTCG on Form 1065 line 9a but did you mean that the PARTNER (not the LP), then reports this amount )from the K-1) on the PARTNERS 1040?

The LP also needs to report the amount from line 16 of Sch D on Form 1040, line 13 I assume your reply above also applies to this since my question is, STOP, forget about it, I thought that LP was Limited Partnership, I see that you are using it for Limited PARTNER.

and then , I guess, need to complete the “Qualified Dividends and Capital Gain Tax Worksheet” to calculate the LP’s LTCG tax on 1040 line 44. The LP’s LTCG tax liability is determined , depending on his marginal tax rate;

if his tax bracket is lower than 25%, then he pays $0 on the LTCG, $9,000, in 2011. If his marginal tax rate is 25% or higher than 25%, then his LTCG tax liability‘d be $1,350; $9,000*15%=$1,350.
Thank you, I am familiar with LT and ST Capital Gains/Losses


“I’m afraid to ask because you might tell me if he withdraw the $9,000, he will have to pay Ordinary Income tax on the $9,000 or DOUBLE TAXATION.”---> No, I don’t think so. The profits of a partnership pass through to its owners, who report their share on their individual tax returns.
AHHHHH, I think we got to the heart of the matter, here is where I am confused. I thought that a Partner can only withdraw the amount of his/her cost basis (never below zero) and the cost basis in this scenario is $1.000 so HOW van the Partner withdraw MORE than his cost basis (without penalty)?


Therefore, the profits are only taxed once (at the personal level of its owners) rather than twice. As said above, his profit, $9,000, LTCG, is NOT subject to double taxation. The profit is LTCG , NOT ordinary gain. A limited partner is akin to a shareholder in a corporation. Because the sale of the LP’s interest involves the sale of his stock, it is subject to state and federal laws dealing with the sale of securities and, unless exempt, must be registered with the SEC and the appropriate state securities authorities.
I assume that this will become clearer to me (i.e. not as CoNfUsInG) when I read your reply to the last paragraph. My question is, how / what / where, does the partner need to do to withdraw (receive a distribution) from the Partnership for Profits that the Partnership made.

Thank you for helping to straighten me out Wnhough,
Bob

“So I am not sure what you mean by the LP Marginal Tax Rate “----> LP’s marginal tax rate is the Limited Partner’s tax bracket(his marginal tax rate) for federal tax purposes; asyou can see, when it comes to paying federal taxes, the amount of money that you pay is based on your marginal tax rate( your tax bracket).
“May be it's just semantics, I understand that LP reports the LTCG on Form 1065 line 9a but did you mean that the PARTNER (not the LP), then reports this amount )from the K-1) on the PARTNERS 1040?”--> OK I see what you mean; here a LP means a Limited Partner, NOT LIMITED PARTNERSHIP(entity), So, yes. As said previously, a partnership distribution is not taken into account in determining the partner's distributive share of partnership income or loss. If any gain or loss from the distribution is recognized by the partner, it must be reported on his or her return for the tax year in which the distribution is received.
“I am familiar with LT and ST Capital Gains/Losses”---> As said, I assumed that your profit, $9,000, is LTCG NOT STCG; STCG is capital gain income from assets held one year or less is taxed at the ordinary income tax rates in effect for the year, ranging from 10% to 35% for 2011, I guess.
“I think we got to the heart of the matter, here is where I am confused. I thought that a Partner can only withdraw the amount of his/her cost basis (never below zero) and the cost basis in this scenario is $1.000 so HOW van the Partner withdraw MORE than his cost basis (without penalty)?”---->As you can see, Partner’s K-1's is filed on the income tax basis. The gain, $9,000 in excess of the basis, $1,000, is reported as a capital gain, LTCG in this particular case. In general, when a partnership interest is sold or exchanged, gain or loss is generally recognized. Because a partnership interest is treated as a capital asset, capital gain or loss is recognized to the transferor partner when the partnership interest is sold.
Please visit the IRS Website here; Publication 541 (12/2010), Partnerships
“I assume that this will become clearer to me (i.e. not as CoNfUsInG) when I read your reply to the last paragraph. My question is, how / what / where, does the partner need to do to withdraw (receive a distribution) from the Partnership for Profits that the Partnership made.”---->I think that it is common sense to say that you need to refer to your partnership agreements including the specifics for each partner, capital, profits and losses, salaries and draws, management, books or etc. I guess basically, these fundamentals are subject to varying legal ramifications by default if not addressed in your partnership agreement. Your partnership agreement may afford you the opportunity to control how to address complex matters within your partnership. In general, money or property withdrawn by a partner in anticipation of the current year's earnings is treated as a distribution received on the last day of the partnership's tax year.

I can't thank you enough Wnhough, it's hard for me to believe that this is almost making sense, thank you you area GREAT help. I began reading the IRS Publications 541 and 731, which are great, I wonder why I wasn't able to find them when I did Google searches, but I am glad that I have them now.
As I assume you expected, I have some additional questions and thought that it might be best that I start a NEW thread, which I will title Partnership - Gain and Losses, so that other forum participants (who may not be interested in this tread), may also benefit from your knowledge.
Thank you Wnhough for ALL your help.
Bob