2.4.1. Inside and Outside Basis: LLCs and Partnerships
Inside basis is the tax basis or adjustable cost basis held by a partnership or limited liability company. Inside basis includes partner contributions and debt made with partnership funds.
Outside basis is the tax basis held by each partner or member of the company, according to her share of partnership contributions. It is the partner’s share of the company’s inside basis. Inside basis belongs to the company; outside basis is apart from the company and belongs to its partners.
The debt incurred by a DPP may be either a recourse loan or a non-recourse loan. A non-recourse loan is one in which the collateral securing the loan is the lender’s only source of repayment should the borrower default. Lenders cannot hold the borrower personally liable for any unrecovered costs. A recourse loan is one in which the lender can go after the borrower’s personal assets in the case of default. Non-recourse loans are common among direct participation programs. Both types of loan are included in a DPP’s tax basis. As we shall see, the distinction becomes important for tax purposes when a DPP’s losses come into play.
Example: A real estate LLC owns four properties, each worth $500,000, and its eight members all have contributed equally to the company’s assets. The inside basis is $2,000,000 ($500,000 x 4). Each partner has an outside basis of $250,000 ($2,000,000 / 8). The sum of each member’s outside basis totals the company’s inside basis.
Suppose in our example that the market value of each of the properties increases from $500,000 to $600,000. The fair market value of the property’s assets is now $2.4 million, but inside and outside basis both remain the same. This is because the cost of these properties to the company has not changed.
On the other hand, if the company sells one of the properties for $600,000, outside basis will increase to $2.1 million, reflecting profits