If you are a partner in a partnership, you will need to
understand a few accounting concepts in order to protect your financial
interests. One accounting idea that many people are unfamiliar with is called
basis. To help you understand basis, here are a few key things to know.
The Basics of Basis
At its core, basis is the accounting terminology for the
amount of money a person or company spends on the purchase or improvement of an
asset. If you buy a vehicle, the purchase price is the biggest element of your
basis in it.
However, for business purposes, you might also add certain
costs like sales tax on the purchase and freight costs to get it from the
manufacturer. Together, these form the basis of the vehicle, which would
represent your cost if you contribute it to the partnership. This is of great
importance because the amount of basis determines the profit you will
potentially pay taxes on or the loss you may deduct.
Inside Basis vs. Outside Basis
When you contribute an asset - whether it is cash, a
building, a piece of equipment, a vehicle, inventory, or something else - your
basis in that individual item is known as the inside basis. This basis is
assigned to each asset and exists inside your overall basis in the company. On
the other hand, the outside basis is your overall contribution to the
partnership.
For example, if you contribute that vehicle (for which you
paid $10,000) as well as $10,000 cash, your outside basis in the partnership is
$20,000. This is how much you stand to lose if the business fails, and it is
generally the limit of how much you can deduct if there is a net loss at the
end of the year. However, the individual $10,000 basis in each individual asset
would be used to calculate certain losses or gains later on.
Partner and Partnership Basis
In addition to inside and outside bases, each asset may also
have two different bases for the partner and the partnership.
If you contribute that vehicle, for instance, the
partnership's basis may be the fair market value of the vehicle. But your
outside basis (stake in the business) is based on your own basis (cost) of the
vehicle. So, if the vehicle is worth $15,000 when your investment is $10,000,
there will be two different bases to calculate.
Adjustments to Basis
Basis is not a fixed number. It can be adjusted up or down
based on many factors. If you make capital improvements to the asset -
something that extends its useful life or boosts its financial value - your
personal basis would be increased.
In addition, your partnership basis is affected by profit,
loss, and partnership transactions. If there is an annual net loss for the
business, it will generally be split up per the partnership agreements and
assigned to the relevant owners. If you contribute additional money or property
to the partnership, your outside basis would increase. And if you take a
distribution, this may decrease your stake in the business.
Finding Help
Both the partnership and each individual partner should
track the various bases for reporting purposes. The partnership would need to
know, for instance, how to record distributions of assets to the partners.
But the bigger responsibility is on the partners, since they
are more directly affected by basis. Each basis and adjustment to basis will
either increase or decrease your taxable income at some point, so you should
have this information available when you need it.
Since basis is a difficult concept to understand
and utilize, consult with an experienced accounting service.
Quality Bookkeeping Services
Inc can guide you through the tracking of your relevant bases as well
as how to use them on your books or taxes. Call today to make an appointment
and learn more.
