Accounting for Partnership Distributions
Paul Schaffer (CFO, Alterna Capital Partners)
| Feb 23, 2010I have a theoretical question governing partnership accounting. If an entity invests $1,000 and expects to earn $300/ year over a five year period (for a total return of $1,500), is the first $1,000 treated as a return of capital, and subsequent distributions (i.e., years 4 and 5) treated as a return on capital, or are the annual distributions split between a return of capital and a return on capital (for simplicity, in this example a s/l distribution would be treated as $200 return of capital and $100 return on capital)? I am new to this forum, appreciate your time and consideration.
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Answers
Company: TPG Credit Management
The first $1,000 would apply to your basis in your example, return of capital is not imputed for each dollar. So your return is on a cash basis as the cash comes in excess of your basis.
Company: Malkani Advisory
The answer to your question depends upon how the $1,000 investment is amortized for tax purposes. You may have flexibility in this treatment. Here is how it works. Before you get to the partners consider how the partnership records the transaction. If the $300 inflow each year is all revenue, and there is $200 of annual depreciation, for net income of $100, that is the tax impact that flows through to the partners. Cash distribution does not affect the taxable treatment of the partnership. So if you are able to select an accelerated depreciation option, you could alter the taxable profile.
Company: In Transition
You will not know the proper treatment of the distribution until the Partnership reports its income. If your share of income for the year is $400 and you recieved $300 the entire amount is a distribution from earnings. If income is only $200 and you received $300 then you have a $100 return of capital. Theoretically if annual income equals or exceeds cash distributions you will not have a return of capital until the deal liquidates. Depending on the structure of the deal you may also be required to account for the effects of your share of partnership debt in calculating basis and gains.
When I account for partnerships I set up each deal with three sub accounts; one for capital contributions, one for cummulative distributions and one for cummulatibve income (loss) allocations. The sum of the sub accounts is the total capital account. You could also set up a fourth sub account for GAAP or book valuation (nontax) changes. This gives you a way to track the cumulative totals for the life of the deal, which at times is difficult to get from GPs.
I got an excellent reference book on Amazon titled "The Logic of SubChapter K" by Laura E. Cunningham. I do not know if this is still in print, but has been a good resource. The book details tax rules for treatment of all partnership transactions, it is not GAAP, but in partnerships you typically base your records on tax. (Fair value accounting is another huge topic) Good luck
Company:
In addition to the above you can designate a part of the distribution as return of capital depending on how you want to treat it. Remember that this is a financial answer, for tax purposes the partners will need to pay income tax based on the net taxable income versus distribution.
Company:
Since the investment cost was $1000 and FMV potentially recognized is 1500. I would treat it aa like an installment sales wherether profit or income would be realized in each year of 5 year annuity. The rate or profit margin at end of annuity is 50%. I would recognize the profit as an installment sale and defer the balance until fully realized. If uncertainties arise and a loss is likely take loss in year it was estimated.
Each annuity 100 recognied & realized and 400 return of capital. defer the balance of the 400 in first year. similar as an installment sale. matching principle and rule of conservatism. Also reconize revenue when complete and reasonably estimatable booking losses when you smell them.