Articles · Advanced · Partnerships and Form 1065
Inside Basis vs. Outside Basis in Partnerships
Partnership tax tracks basis at two levels. Inside basis is the partnership's basis in its assets, and outside basis is each partner's basis in their partnership interest.
Calculating outside basis
Outside basis starts with cash and the adjusted basis of property contributed under Section 722, or the purchase price. It rises with allocated income and a share of liabilities under Section 752. It falls with allocated losses, distributions, and reductions in liabilities.
Under Section 704(d), losses are deductible only up to outside basis. Excess losses are suspended until basis is restored.
Why the two diverge
At formation, total outside basis often equals total inside basis. Purchases of interests can change that. If a buyer pays $300,000 for an interest whose share of inside basis is $200,000, the buyer's outside basis exceeds their share of inside basis by $100,000.
Without an adjustment, the buyer could be taxed on built-in gains they effectively paid for. A Section 754 election can address this.
Common review points
The tax capital reported on a Schedule K-1 is not outside basis, because it excludes liabilities. Partners should keep their own basis schedule. A deemed distribution from a reduction in liabilities can trigger gain if it exceeds outside basis.
Key takeaways
- Outside basis includes a share of liabilities.
- Purchases of interests can create inside-outside differences.
- Partners need their own basis schedules.
For general education only, not tax advice. Tax law changes often, so confirm current rules and amounts with primary sources.