The basis in an investment refers to a party’s economic interest in the investment. In other words, it is used to describe the amount of value that you’ve imparted to the investment. If you invest $10 in stock and then sell it for $15, the original $10 is your basis and the $5 you’ve earned is the recognized gain. However, the concept quickly becomes more complicated when investment structures become more complex, especially in the case of a partnership. CCH® CPELink explains the concepts of inside and outside basis of a partnership and their significance to partners and the partnership.
Basis in a Partnership
Two distinct concepts of basis apply to the partnership and to each partner. The partnership has what is known as an inside basis, which is an adjusted basis in its assets. Then, each partner has an adjusted basis in their respective partnership interest, called the outside basis. To illustrate, consider this example: You contribute $50,000 in cash to a partnership. Your partner contributes land with a fair market value of $50,000 and a tax basis of $10,000. Thus, the total inside basis of the partnership is $100,000, but each partner’s outside basis is different. If your partner sells their partnership interest for $50,000, they would recognize a gain of $40,000, while if you sold your interest in the partnership for the same price, you would recognize no gain or loss.
When Are Inside and Outside Basis Important?
The amount of a partner’s adjusted basis becomes significant in a number of circumstances, such as calculating the partner’s recognized gain or loss upon the distribution of property by the partnership, determining the deductibility of partnership losses, and calculating a gain or loss with the sale or exchange of a partnership interest. Also, understanding inside and outside basis is important when it comes to filing taxes.
Some common situations that increase a partner’s outside basis are:
- A contribution of cash, property, or services
- An increased share of partnership liabilities
- Any recognized income, including tax-exempt income
Common situations that decrease a partner’s outside basis are:
- Any distribution of cash or property
- A decreased share of partnership liabilities
- Any recognized losses or deductions, including nondeductible expenses
Inside and outside basis may not match; a partner’s capital account may not match their outside basis; and a partner’s capital account may or may not affect their basis. Knowing the ins and outs of basis in a partnership is key to understanding each partner’s tax basis and the proper recognition of gains and losses.
Learn More About Inside and Outside Basis from CCH CPELink
For CPAs, tax professionals, and others in the financial industry dealing with partnerships, it’s important to stay up to date on how inside and outside basis work and the latest requirements and regulations for filing taxes. CCH CPELink offers a wide array of online self-study courses or live webinars that can be taken at your convenience.