“Surk’s” up basis
On October 29, 2024, the Tax Court issued its opinion in the case of
Surk LLC v. Commissioner, T.C. Memo 2024-99, a case involving the impact on basis of a partnership interest when an LLC member improperly deducted losses for which the taxpayer had no basis. The taxpayer improperly deducted pass-through losses from an LLC in 2014 and 2015, violating the basis limitation rules of §704(d), which limits a partner’s ability to deduct losses only to the extent the partner has basis in the partnership interest at the end of the tax year in which the loss occurred. The IRS did not challenge these “excess losses,” deducted in tax years that were closed by the statute of limitations, nor did the IRS dispute the amount of the excess losses at trial. Rather, the IRS asserted that the taxpayer must decrease the basis in its LLC interest for 2017, the year under examination and before the Tax Court, to “account for the excess loss.”
The Tax Court agreed with the IRS and held that previously deducted losses of the taxpayer “must decrease its outside basis by the excess losses for its annual calculation of outside basis for purposes of section 704(d)” to arrive at the “proper outside basis calculation for 2017 and for future years.” Determining basis for a partnership interest is always an open issue under the statute of limitations, and, therefore, requires the member to analyze all tax years, both open and closed. Losses deducted in violation of the basis limitation rules of §704(d) by a partner must reduce the partner’s basis in future years.
For example, Andy is a member in XYZ LLC (partnership), which allocated 2019 losses of $1,000 to Andy. Notwithstanding that Andy had no basis in his XYZ LLC interest prior to the allocation of the $1,000 loss to Andy at the end of the 2019 tax year (for example, there was a contribution of capital to the LLC in 2019 and pursuant to §704(b) the LLC’s assets were revalued, Andy’s §704(b) capital account was correspondingly increased, and the losses allocated to Andy exceeded his tax basis), Andy improperly deducted his $1,000 of pass-through loss on his Form 1040. For tax years 2020 through 2023, Andy’s basis in XYZ LLC did not change. Andy’s 2024 Schedule K-1 reflected $1,500 of income allocated to Andy, increasing his basis from $0 to $1,500. Following the Tax Court’s opinion in
Surk, Andy’s outside basis must be reduced from $1,500 to $500, because Andy deducted a $1,000 loss in 2019 when he lacked basis to support the loss.