NO Analytics - Basis, Distribution, and Suspended Loss
Nadia is a 50% member of NO Analytics LLC, a calendar-year entity taxed as a partnership with no debt and no §754 election. She materially participates and is not passive. Her outside basis on January 1, 2024, was $22,000. For 2024 the partnership allocated her $48,000 of ordinary operating loss and $4,000 of tax-exempt interest income. On November 6, 2024, the LLC distributed $30,000 cash to her; she made no contributions and received no other distributions. The partnership's 2024 Form 1065 was timely filed showing the loss allocation and the distribution. On her 2024 Form 1040, Nadia's preparer deducted the entire $48,000 and treated the distribution as nontaxable.
1. Compute Nadia's 2024 basis and her deductible loss. Show each step and explain the ordering rule that drives the answer.
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Step 1 - starting basis. Outside basis, 1/1/2024: $22,000.
Step 2 - increases. Her share of tax-exempt income increases basis under §705(a)(1)(B): $22,000 + $4,000 = $26,000. No contributions, no taxable income allocations.
Step 3 - distribution. Under §733 and §705(a)(2) the $30,000 cash distribution reduces basis to zero, and the $4,000 excess is gain under §731(a)(1): $26,000 - $30,000 = -$4,000. Basis after the distribution: $0.
Step 4 - loss limitation. §704(d) permits the $48,000 loss only to the extent of adjusted basis at the end of the partnership year, determined after taking distributions into account (Reg. §1.704-1(d)(2)). Basis is $0, so the deductible loss is $0 and the full $48,000 is suspended and carried forward indefinitely.
Result. 2024: $4,000 of capital gain (unless §751 applies), $4,000 of tax-exempt interest, and no loss deduction. The preparer's return is wrong on both items.
Ordering matters. If the loss had been applied before the distribution, the outcome would be worse: $26,000 of loss allowed, then a $30,000 distribution against zero basis and a $30,000 gain.
2. Is the $4,000 gain capital or ordinary? And does the suspended loss affect her at-risk amount or her §199A deduction?
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Character of the gain. §731(a)(1) treats gain from a distribution exceeding basis as gain from the sale or exchange of the partnership interest - capital, except to the extent §751 hot assets (substantially appreciated inventory, unrealized receivables) are present. NO Analytics appears to have no hot assets, and she has held the interest since 2022, so it is long-term capital gain.
At-risk. §704(d) and §465 are separate limits. Because the LLC has no debt, her at-risk amount equals her basis here. If the LLC had borrowed, her share of the liabilities would increase both basis and at-risk for a general-recourse obligation, but nonrecourse debt is at-risk only in the real property context. The $48,000 is a §704(d) suspension, tracked partner-by-partner; an amount also disallowed under §465 follows different carryforward rules. Keep a basis and at-risk schedule every year.
§199A. Because the loss is suspended under §704(d), it does not reduce QBI in 2024 - QBI from the LLC is effectively zero. The suspended amount reduces QBI in the year it is allowed. The $4,000 capital gain is not QBI, and material participation affects only the passive activity rules, not §704(d).
3. What could have been done differently in 2024, and how does Nadia use the suspended loss going forward?
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In 2024. The distribution was only $4,000 over her basis. Any of these would have avoided the gain: deferring the distribution into January 2025 (after income allocations and any contribution raised basis); contributing $4,000 or more before the distribution; or having the LLC borrow, which allocates liability share and increases basis. Alternatively, the LLC could have limited the distribution to her basis and distributed the remainder in the next year.
Going forward. The $48,000 suspended loss is released only when basis increases: future allocations of partnership income, additional capital contributions, or her share of partnership liabilities. Because she materially participates, the passive activity rules will not block it; the at-risk rules will if her at-risk amount falls below basis, and the two carryforwards must be tracked separately. Remind her that the basis computation is the partner's responsibility, not the partnership's - the K-1's distribution line and tax-exempt income line are inputs, not the answer. Also flag the disclosure issue: the 2024 return as filed understates income by $4,000 and overstates the loss by $48,000, so a superseding or amended return before the IRS matches the K-1 avoids a §6662 accuracy penalty.