U.S. Return of Income for Electing Large Partnerships

Assembling the Return

When submitting Form 1065-B, organize the pages of the return in the following order:

• Pages 1-5,
• Schedule F (Form 1040) (if required),
• Form 8825 (if required),
• Any other schedules in alphabetical order, and
• Any other forms in numerical order.

To assist us in processing the return, complete every applicable entry space on Form 1065-B and Schedule K-1. If you attach statements, do not write See attached instead of completing the entry spaces on the forms. Penalties may be assessed if the partnership files an incomplete return.

If you need more space on the forms or schedules, attach separate sheets and place them at the end of the return. Use the same size and format as on the printed forms. But show your totals on the printed forms. Be sure to put the partnership's name and EIN on each sheet.

Overview

The taxable income of an electing large partnership is computed in the same manner as that of an individual, except that the items described below are separately stated and certain modifications are made. These modifications include not allowing the deduction for personal exemptions, the net operating loss deduction, and certain itemized deductions. Other itemized deductions are modified.

The netting of capital gains and losses occurs at the partnership level. Such net capital gain (loss) is treated as long-term capital gain (loss). Any excess of net short-term capital gain over net long-term capital loss is consolidated with the partnership's other taxable income and is not separately reported.

General credits are separately reported to partners as a single item. They are taken into account by partners as a current year general business credit. General credits are those credits that are not separately reported. The refundable credit for Federal tax paid on fuels and the refund or credit for tax paid on undistributed capital gains of a regulated investment company or a real estate investment trust are taken by the partnership and thus are not separately reported to partners. The partnership also recaptures the investment credit and low-income housing credit.

Separately Stated Items

Partners must take into account separately (under section 772(a)) their distributive shares of the following items (whether or not they are actually distributed):

• Taxable income or loss from passive loss limitation activities.
• Taxable income or loss from other activities (e.g., portfolio income or loss).
• Net capital gain or loss allocable to passive loss limitation activities.
• Net capital gain or loss allocable to other activities.
• 28% rate gain or loss allocable to passive loss limitation activities.
• 28% rate gain or loss allocable to other activities.
• Qualified 5-year gain.
• Tax-exempt interest income.
• Extraterritorial income exclusion and foreign trading gross receipts.
• Net alternative minimum tax (AMT) adjustment separately computed for passive loss limitation activities.
• Net AMT adjustment separately computed for other activities.
• General credits.
• Low-income housing credit.
• Rehabilitation credit from rental real estate activities.
• Credit for producing fuel from a nonconventional source.
• Creditable foreign taxes and foreign source items.
• Other items of income, gain, loss, deduction, or credit, to the extent the IRS determines separate treatment is appropriate. Examples of such items include gains on sales of qualified small business stock (information required for a section 1202 exclusion or section 1045 rollover).

Note: For electing large partnerships, the term passive loss limitation activities includes trade or business, rental real estate, and other rental activities. Partnership items from passive loss limitation activities allocated to limited partners are treated as being from passive activities and subject to the passive activity limitations. However, general partners may have materially or actively participated in some or all of these passive loss limitation activities. Each general partner must determine if any partnership items from these activities are subject to the passive activity limitations. To allow each general partner to correctly apply the passive activity limitations, the partnership must report income or loss and credits separately for each trade or business activity, rental real estate activity, rental activity other than rental real estate, and other activities (e.g., portfolio income). See page 9 for details.

The character of any item separately stated to the partners is based on its character to the partnership. The items are treated as incurred by the partnership, similar to the character rule for other partnerships under section 702(b).

Limitations

Most limitations and other provisions affecting taxable income or credit are applied at the partnership level except for:

• Section 68 - Overall itemized deduction limitation.
• Sections 49 and 465 - At-risk limitations.
• Section 469 - Passive loss limitations.

For example, the limitation on miscellaneous itemized deductions is applied at the partnership level. However, instead of the 2% floor, 70% of the partnership's total miscellaneous itemized deductions are disallowed.

Another limitation that is applied at the partnership level is the deduction for charitable contributions. The deduction is limited to 10% of the partnership's taxable income (before the charitable contribution deduction).

Elections Made by the Partnership

All elections, other than the exceptions listed under Elections Made by Each Partner, affecting the computation of taxable income or any credit are made by the partnership. For example, it chooses the accounting method and depreciation methods it will use. The partnership also makes elections under the following sections:

1. Section 179 (election to expense certain tangible property).
2. Section 1033 (involuntary conversions).
3. Section 754 (manner of electing optional adjustment to basis of partnership property).

   There are no changes to the optional basis adjustment provisions as a result of the electing large partnership rules. Under section 754, a partnership may elect to adjust the basis of partnership property when property is distributed or when a partnership interest is transferred. Once an election is made under section 754, it applies both to all distributions and to all transfers made during the tax year and in all subsequent tax years unless the election is revoked. See Regulations section 1.754-1(c).

   This election must be made in a statement that is filed with the partnership's timely filed return (including any extension) for the tax year during which the distribution or transfer occurs. The statement must include:

   • The name and address of the partnership.
   • A declaration that the partnership elects under section 754 to apply the provisions of section 734(b) and section 743(b).
   • The signature of the general partner authorized to sign the partnership return.

   The partnership can get an automatic 12-month extension to make the section 754 election provided corrective action is taken within 12 months of the original deadline for making the election. For details, see Regulations section 301.9100-2.

   See section 754 and the related regulations for more information.

   If there is a distribution of property consisting of an interest in another partnership, see section 734(b).

The partnership is required to attach a statement for any section 743(b) basis adjustments. See page 7 for details.

Elections Made by Each Partner

Elections under the following sections are made by each partner separately on the partner's tax return:

1. Section 108 (income from discharge of indebtedness). If an electing large partnership has income from the discharge of any indebtedness, this is reported separately to each partner.
2. Section 901 (foreign tax credit).

Partner's Dealings With Partnership

If a partner engages in a transaction with his or her partnership, other than in his or her capacity as a partner, the partner is treated as not being a member of the partnership for that transaction. Special rules apply to sales or exchanges of property between partnerships and certain persons, as explained in Pub. 541, Partnerships.

Contributions to the Partnership

Generally, no gain (loss) is recognized to the partnership or any of the partners when property is contributed to the partnership in exchange for an interest in the partnership. This rule does not apply to any gain realized on a transfer of property to a partnership that would be treated as an investment company (within the meaning of section 351) if the partnership were incorporated. If, as a result of a transfer of property to a partnership, there is a direct or indirect transfer of money or other property to the transferring partner, the partner may have to recognize gain on the exchange.

The basis to the partnership of property contributed by a partner is the adjusted basis in the hands of the partner at the time it was contributed, plus any gain recognized (under section 721(b)) by the partner at that time. See section 723 for more information.

Dispositions of Contributed Property

If the partnership disposes of property contributed to the partnership by a partner, income, gain, loss, and deductions from that property must be allocated among the partners to take into account the difference between the property's basis and its FMV at the time of the contribution.

For property contributed to the partnership, the contributing partner must recognize gain or loss on a distribution of the property to another partner within 5 years of its being contributed. For property contributed after June 8, 1997, the 5-year period is generally extended to 7 years. The gain or loss is equal to the amount that the contributing partner should have recognized if the property had been sold for its FMV when distributed, because of the difference between the property's basis and its FMV at the time of contribution.

See section 704(c) for details and other rules on dispositions of contributed property. See section 724 for the character of any gain or loss recognized on the disposition of unrealized receivables, inventory items, or capital loss property contributed to the partnership by a partner.

Recognition of Precontribution Gain on Certain Partnership Distributions

A partner who contributes appreciated property to the partnership must include in income any precontribution gain to the extent the FMV of other property (other than money) distributed to the partner by the partnership exceeds the adjusted basis of his or her partnership interest just before the distribution. Precontribution gain is the net gain, if any, that would have been recognized under section 704(c)(1)(B) if the partnership had distributed to another partner all the property that had been contributed to the partnership by the distributee partner within 5 years of the distribution and that was held by the partnership just before the distribution. For property contributed after June 8, 1997, the 5-year period is generally extended to 7 years.

Appropriate basis adjustments are to be made to the adjusted basis of the distributee partner's interest in the partnership and the partnership's basis in the contributed property to reflect the gain recognized by the partner.

For more details and exceptions, see
Pub. 541.

Unrealized Receivables and Inventory Items

Generally, if a partner sells or exchanges a partnership interest and unrealized receivables or inventory items are involved, the transferor partner must notify the partnership, in writing, within 30 days of the exchange. The partnership must then file Form 8308, Report of a Sale or Exchange of Certain Partnership Interests.

If a partnership distributes unrealized receivables or substantially appreciated inventory items in exchange for all or part of a partner's interest in other partnership property (including money), treat the transaction as a sale or exchange between the partner and the partnership. Treat the partnership gain (loss) as ordinary income (loss). The income (loss) is specially allocated only to partners other than the distributee partner.

If a partnership gives other property (including money) for all or part of that partner's interest in the partnership's unrealized receivables or substantially appreciated inventory items, treat the transaction as a sale or exchange of the property.

See Rev. Rul. 84-102, 1984-2 C.B. 119, for information on the tax consequences that result when a new partner joins a partnership that has liabilities and unrealized receivables. Also, see Pub. 541 for more information on unrealized receivables and inventory items.

Activities of Electing Large Partnerships

The activities of an electing large partnership are reported as either:

• Passive loss limitation activities, including trade or business, real estate rental, and other rental activities or
• Other activities, including portfolio or investment activities.

Passive Loss Limitation Activities

The term passive loss limitation activity means any activity involving the conduct of a trade or business (including any activity treated as a trade or business under section 469(c)(5) or (6)), or any rental activity.

A limited partner's share of an electing large partnership's taxable income or loss from these activities is treated as income or loss from the conduct of a single passive trade or business activity. Thus, an electing large partnership does not have to report items from multiple activities separately to limited partners.

However, if a partner holds an interest in an electing large partnership other than as a limited partner, the distributive share of items from each activity is accounted for separately under the passive activity rules of section 469. Thus, for example, passive loss limitation activity income or loss is not treated as passive income with respect to the general partnership interest of a partner who materially participates in the partnership's trade or business activities. For general partners, the partnership does have to report items for each activity separately.

Trade or Business Activities

A trade or business activity is an activity (other than a rental activity or an activity treated as incidental to an activity of holding property for investment) that:

1. Involves the conduct of a trade or business (within the meaning of section 162),
2. Is conducted in anticipation of starting a trade or business, or
3. Involves research or experimental expenditures deductible under section 174 (or that would be if you chose to deduct rather than capitalize them).

Rental Activities

Generally, except as noted below, if the gross income from an activity consists of amounts paid principally for the use of real or personal tangible property held by the partnership, the activity is a rental activity.

There are several exceptions to this general rule. Under these exceptions, an activity involving the use of real or personal tangible property is not a rental activity if any of the following apply:

• The average period of customer use (defined below) for such property is 7 days or less.
• The average period of customer use for such property is 30 days or less and significant personal services (defined below) are provided by or on behalf of the partnership in making the property available for customer use.
• Extraordinary personal services (defined below) are provided by or on behalf of the partnership.
• The rental of such property is treated as incidental to a nonrental activity of the partnership under Temporary Regulations section 1.469-1T(e)(3)(vi).
• The partnership customarily makes the property available during defined business hours for nonexclusive use by various customers.
• The partnership provides property for use in a nonrental activity of a partnership or joint venture in its capacity as an owner of an interest in such partnership or joint venture. Whether the partnership provides property used in an activity of another partnership or of a joint venture in the partnership's capacity as an owner of an interest in the partnership or joint venture is determined on the basis of all the facts and circumstances.

In addition, a guaranteed payment described in section 707(c) is not income from a rental activity under any circumstances.

Average period of customer use. Figure the average period of customer use for a class of property by dividing the total number of days in all rental periods by the number of rentals during the tax year. If the activity involves renting more than one class of property, multiply the average period of customer use of each class by the ratio of the gross rental income from that class to the activity's total gross rental income. The activity's average period of customer use equals the sum of these class-by-class average periods weighted by gross income. See Regulations section 1.469-1(e)(3)(iii).

Significant personal services. Personal services include only services performed by individuals. To determine if personal services are significant personal services, consider all the relevant facts and circumstances. Relevant facts and circumstances include how often the services are provided, the type and amount of labor required to perform the services, and the value of the services in relation to the amount charged for use of the property.

The following services are not considered in determining whether personal services are significant:

• Services necessary to permit the lawful use of the rental property.
• Services performed in connection with improvements or repairs to the rental property that extend the useful life of the property substantially beyond the average rental period.
• Services provided in connection with the use of any improved real property that are similar to those commonly provided in connection with long-term rentals of high-grade commercial or residential property. Examples include cleaning and maintenance of common areas, routine repairs, trash collection, elevator service, and security at entrances.

Extraordinary personal services. Services provided in connection with making rental property available for customer use are extraordinary personal services only if the services are performed by individuals and the customers' use of the rental property is incidental to their receipt of the services.

For example, a patient's use of a hospital room generally is incidental to the care received from the hospital's medical staff. Similarly, a student's use of a dormitory room in a boarding school is incidental to the personal services provided by the school's teaching staff.

Rental activity incidental to a nonrental activity. An activity is not a rental activity if the rental of the property is incidental to a nonrental activity, such as the activity of holding property for investment, a trade or business activity, or the activity of dealing in property.

Rental of property is incidental to an activity of holding property for investment if both of the following apply:

• The main purpose for holding the property is to realize a gain from the appreciation of the property.
• The gross rental income from such property for the tax year is less than 2% of the smaller of the property's unadjusted basis or its FMV.

Rental of property is incidental to a trade or business activity if all of the following apply:

• The partnership owns an interest in the trade or business at all times during the year.
• The rental property was mainly used in the trade or business activity during the tax year or during at least 2 of the 5 preceding tax years.
• The gross rental income from the property for the tax year is less than 2% of the smaller of the property's unadjusted basis or its FMV.

The sale or exchange of property that is both rented and sold or exchanged during the tax year (where the gain or loss is recognized) is treated as incidental to the activity of dealing in property if, at the time of the sale or exchange, the property was held primarily for sale to customers in the ordinary course of the partnership's trade or business.

See Temporary Regulations section 1.469-1T(e)(3) and Regulations section 1.469-1(e)(3) for more information on the definition of rental activities for purposes of the passive activity limitations.

In reporting the partnership's income or losses and credits from rental activities, the partnership must separately report rental real estate activities and rental activities other than rental real estate activities.

Partners who actively participate in a rental real estate activity may be able to deduct part or all of their rental real estate losses (and the deduction equivalent of rental real estate credits) against income (or tax) from nonpassive activities. The combined amount of rental real estate losses and the deduction equivalent of rental real estate credits from all sources (including rental real estate activities not held through the partnership) that may be claimed is limited to $25,000. This $25,000 amount is generally reduced for high-income partners.

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