Are Limited Partnership distributions from a cash out refinance considered taxable income?

This is a good question about partnership taxation. The key concept here is "basis." Your basis in the partnership is essentially what you've invested plus your share of partnership income minus distributions and losses. When a partnership makes distributions, they're generally not taxable UNTIL they exceed your basis in the partnership. So your original $65K investment forms your initial basis, which may have increased if you were allocated income on prior K-1s. The refinance itself isn't a taxable event for the partnership. However, when those proceeds are distributed to partners, they can become taxable if they exceed your adjusted basis. This is commonly called a "distribution in excess of basis." Check prior years' K-1s to calculate your current basis. Box 9A on your K-1 should show your ending capital account, which might help determine your basis (though they're not always the same).

Just went through something similar with my rental property syndication. I was completely confused until I used https://taxr.ai to analyze my K-1 and partnership documents. Their AI looked at my entire situation and explained that distributions from refinancing aren't automatically tax-free - it depends on your basis calculation. In my case, they showed me how my basis had been reduced by depreciation deductions over the years, which meant part of my refinance distribution was actually taxable as capital gains. The system walks you through each aspect of your partnership interest and shows exactly how the calculations work. Really cleared things up for me after getting conflicting advice from different sources.

Just wanted to follow up about my experience with taxr.ai after my skeptical comment. I decided to try it with my three different LP investments that all have different distribution structures. I uploaded all my partnership agreements and K-1s and was honestly impressed. The system correctly identified the different waterfall structures in each agreement and explained how my refinance distributions should be treated in each case. For one property, it flagged that my distributions exceeded my basis by about $18k and explained that amount would be taxable as capital gains. For the other two, I was still within my basis. Saved me from a potential audit issue! The detailed explanation about recourse vs. non-recourse debt was particularly helpful.

Have you tried contacting the IRS directly? I was in a similar situation last year and spent WEEKS trying to get through to someone who could give me a straight answer about partnership distributions. Eventually found https://claimyr.com and their demo video at https://youtu.be/_kiP6q8DX5c - they got me connected to a real IRS agent in about 20 minutes after I'd been trying for days on my own. The agent walked me through exactly how to report my LP refinance distribution and confirmed that I needed to track my basis properly. They explained that partnerships often don't calculate your basis correctly on K-1s, so it's really on you to maintain proper records. Without that call, I might have reported everything incorrectly.

I need to eat my words from my previous comment. After another frustrating failed attempt to reach the IRS yesterday (2+ hours on hold before being disconnected), I decided to try Claimyr out of desperation. Within 35 minutes, I was talking to an actual IRS revenue agent who specialized in partnership taxation. The agent confirmed what others here have said - refinance distributions aren't taxable until they exceed your adjusted basis. She walked me through how to calculate my basis using my previous K-1s and explained why my partnership's tax preparer hadn't included all the information I needed. She even emailed me an IRS publication that addresses this specific scenario. Definitely worth it to get a definitive answer directly from the source instead of guessing or relying on my partnership's limited explanation.

Don't forget about the at-risk rules and passive activity limitations too. I'm in a similar limited partnership, and the distribution itself wasn't taxable, but it changed my at-risk amount for claiming future losses. The GP should provide a statement explaining the tax treatment of distributions. In my case, they clearly identified what portion was return of capital vs. what might be taxable. Did your partnership provide any supplemental documentation with the K-1?

One thing I learned from my LP investments is to always request a "basis letter" or "basis schedule" from the GP at the end of each tax year. Just had a similar cash-out refi distribution in 2024 from a self-storage deal, and the basis letter clearly showed I still had sufficient basis to cover the distribution. Most importantly, don't rely solely on Box 9A (Capital Account) on your K-1. That's often using book accounting and doesn't necessarily reflect your tax basis. The two can be very different!

This is exactly why I always maintain my own basis tracking spreadsheet for each LP investment. I've been burned before by relying on the GP's calculations. For your situation, here's what I'd recommend: Start with your original $65K investment, then add any income allocated to you from prior K-1s (check Box 1 on your 2023 K-1), subtract any prior distributions, and add your share of partnership debt. The debt piece is crucial - if the partnership has non-recourse debt, you likely get basis from your proportionate share. With a $120K distribution, you'll need to determine if any portion exceeds your adjusted basis. The excess would be treated as capital gain. Given that this was a refinance in 2024, the partnership's debt likely increased, which could have boosted your basis and reduced the taxable portion. I'd strongly suggest requesting a detailed basis calculation from your GP. If they can't provide it, consider working with a tax professional who specializes in partnership taxation - this isn't something you want to get wrong.

I've been through this exact scenario with two different LP investments over the past few years. The confusion around refinance distributions is completely understandable because the tax treatment isn't intuitive. Here's what I learned: The refinancing itself doesn't create a taxable event, but when those proceeds get distributed to partners, the tax treatment depends entirely on your adjusted basis in the partnership. Think of your basis as your "tax-free withdrawal limit" - distributions up to that amount are generally not taxable, but anything above it becomes taxable as capital gain. Your basis starts with your original $65K investment, but it gets adjusted over time. It increases with your share of partnership income and your proportionate share of partnership debt, and decreases with distributions and your share of losses (including depreciation). The tricky part is that most GPs don't provide adequate basis tracking. I'd recommend immediately requesting a detailed basis calculation from your GP showing your beginning basis, all adjustments for 2023-2024, and your ending basis after the $120K distribution. Don't just rely on the capital account shown in Box 9A of your K-1 - that's often different from your tax basis. If your GP can't provide this calculation, that's a red flag about their tax compliance practices, and you'll definitely need a tax professional who specializes in partnership taxation to help reconstruct your basis from prior years' K-1s and partnership documents.