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Zero-Sum Gain: Profit Is Reported on a Loss
Withdrawing Member Questions Club’s Bookkeeping
I received a question regarding a large capital gain reported on the Schedule K-1 of a withdrawn club member. The member had a loss on his investment in the club. So why is there a capital gain reported?
The answer lies in the purpose of the K-1. The K-1 reports a partner’s share of club income and expenses for the tax year. It doesn’t report the gain or loss from liquidating a partnership position.
In this case the club had disbanded. All stocks were sold, generating a large capital gain in the current tax year. This member hadn’t withdrawn before the gains were realized by the club. So members were allocated their share of the club’s capital gains. It was this gain that was reported on their K-1. The deciding factor in allocating gains is being a partner when the gains are realized. It doesn’t matter whether all the stock was purchased before someone became a member. As long as you were a member when the gains were realized, you’ll be allocated a share of the gains at year-end. This applies to all income and expense items, not just to capital gains.
The K-1 does have some withdrawal reporting function. There’s a line for distributions received on the K-1. This line will show the total amount received in a withdrawal distribution. It doesn’t report gain from this distribution. The Withdrawal Report from myICLUB and Club Accounting 3 does provide gain/loss information from a withdrawal, including cost-basis details.
The income reported on the K-1 does have an impact on withdrawals. The allocation process at year-end adds each member’s share of total income to his cost basis in the club. This cost-basis adjustment then affects the gain at withdrawal. A final allocation of income is part of the withdrawal process.
The software allocates income for the year to date for a withdrawing member. This information appears on the withdrawal report and on the K-1 of the withdrawn member for that tax year.
Russell Malley is the Club Accounting Adviser for ICLUBcentral.