Stock Basis Question-Need help settling an argument

[gfizer]

I prepare tax returns for an investment club which is organized as a general partnership consisting of 21 members/partners. The club began in 1988 with each member contributing $500, which was used to purchase stock. The club receives stock dividends which are held in a money market account with a brokerage firm. In addition, each member makes an annual contribution of $300. A couple of times each year, the members meet and decide what new stocks to purchase with the accumulated dividends, annual contributions and any gains from stock sales. No funds are ever distributed to the individual members. Each year we prepare a 1065 and pass the dividends, interest, and any gain or losses through to the individual members/partners.

In 2010 the club decided to sell substantially all of its holdings, thereby netting a gain of approximately $145,000. I have shown each stock sale on schedule D showing the sale price and the cost basis. One of the members is insisting that since they never received any cash distributions of the income and yet paid tax on it every year, that the income amounts provide additional basis. I disagree because the income was used to purchase other stocks thereby providing basis for those new stock purchases. It appears to me that we would be double-dipping if we use the income as additional basis and then also use it as basis for the other stock acquisitions. Since we are talking about an $83,000.00 difference I thought I would get some input from you guys. Any thoughts?

[jainen]

>>the income amounts provide additional basis<<

I think I agree with the other member, gfizer. The income did increase your basis. But perhaps we are talking about two different things. Additional basis in WHAT?

[OldJack]

The argument is about 2 separate basis. The members tax basis (capital account or outside basis) in the partnership "entity" increases or decreases by 1065-k1 items but has nothing to do with the basis of purchased stock. The partner's entity basis only comes into play on part or all disposition/sale of his interest in the partnership. A simple way of looking at it is you might say his partnership basis is in the cash produced by the sale of the partnership assets in liquidation of the partnership.

As an example, when he receives cash or property distributions they will not be taxable to him unless they exceed his partnership entity basis (capital account or outside basis). The reason is he has already paid tax on that income and his basis therefore increased (or decreases if loss).

Therefore you are right that his entity basis does not increase the stock profit or loss on Sch-D. He is right that his "partner basis" increases on all the assets as income is reported on the 1065-k1. He just has to wait to use his partner basis until he receives cash or assets.