Schedule K-1: Capital percentage, what is someone has not contributed capital but own 50% of shares?

Question

Basically, I wonder if the capital percentages relate to capital accounts or is it share of capital. If there are losses in a year and someone has not had capital contributions, are they 0% for capital?

Answer 1

From the instructions:

The ending percentage share shown on the Capital line is the portion of the capital you would receive if the partnership was liquidated at the end of its tax year by the distribution of undivided interests in the partnership's assets and liabilities. If your capital account is negative or zero, the partnership will have entered zero on this line.

So this is share of capital, not your basis. I.e.: if you had no capital contributions, but by the partnership agreement you own some of the partnership capital - this line will have the value of your share of ownership.

Answer 2

YOU SHOULD TALK TO A TAX PROFESSIONAL ASAP. THIS IS NOT TAX ADVICE.

With that disclaimer out of the way, the core of your question is the distinction between a "capital interest" and a "profit interest" in a flow-though entity.

A capital interest is just that: you contribute capital, you have an interest, typically proportional to your capital contribution. Receiving a capital interest that is disproportionate to your capital contribution can trigger a tax liability at the time it is received, unless you are able to, e.g., make a timely nil-value 83(b) election, which will be determined based on the facts and circumstances--but this is typically quite tricky in the case of a capital interest.

A profit interest is a distinct type interest in a flow-through entity that you receive without making a capital contribution. This is often referred to as the "promote" or "carried interest" in an investment or business venture. Typically, value does not start to accrue to the profit interest until, e.g., the capital interest receives back invested capital plus a profit thereon. Partly because of this, it's much easier to claim nil-value in a timely 83(b) (although, again, facts and circumstances).

The vast majority of flow-through entities will only have capital interests; entities used to structure, e.g., real estate or O&G investments may have both capital interests and profit interests; it's also possible to have an entity that only has profit interests, but you usually only encounter these as SPVs used in very sophisticated deal / private fund structuring.

Based on your description, i.e., owning a 50% [interest] without contributing capital, you may be dealing with profit interests. Generally speaking, profit interests are not allowed to claim losses because they did not contribute capital, have $0 tax basis.

Your situation sounds somewhat complex; I would strongly urge you to consult with a tax professional with advanced experience in taxation of flow-through entities (your lock H&R Block / TurboTax simply will not do). Someone who is used to dealing with tax for large (commercial) real estate investments will likely have this experience (among others). You may also need a tax lawyer to interpret the legal agreements that gave rise to this interest. The good news is that you'll probably only need to pay for this advice once; the bad news is that if you don't deal with this correctly, the consequences can be incredible serious.

Good luck!