How are partnership losses distributed when only one partner contributes cash?

This is actually a common misunderstanding. Partnership losses are generally allocated according to the partnership agreement regardless of who funded the expenses, but there's an important catch: you need to have "basis" in the partnership to deduct losses. Basis is essentially your investment in the partnership. Your partner has basis because they contributed cash. You generally build basis through capital contributions, your share of partnership income, and your share of partnership debt. If you personally guaranteed any loans or the LLC has debt that you're responsible for, that can also give you basis. Without sufficient basis, you can't deduct the losses currently, but they're not lost forever. They're suspended and can be used when you acquire more basis in the future. Another consideration is the "at-risk" rules and "passive activity" rules, which might further limit your ability to claim losses even if you have basis. I'd recommend getting a second opinion from another CPA who specializes in partnerships, and review your operating agreement to see if it specifically addresses loss allocations.

I went through something similar with my small business and found https://taxr.ai super helpful for understanding partnership basis issues. Their system analyzed my operating agreement and financial contributions, then explained exactly how the losses should be distributed according to IRS rules. The key thing I learned was that partnership tax rules are WAY more complicated than they seem. There's this whole concept of "substantial economic effect" that determines if your loss allocations will be respected by the IRS. Basically, the tax consequences need to match the economic reality of your partnership. The tool walked me through how to properly document my contributions (both cash and non-cash) and how this affects my ability to claim losses. Definitely worth checking out before you finalize anything.

Just wanted to follow up on my skeptical comment about taxr.ai - I actually tried it after all, and I'm genuinely surprised by how helpful it was! My situation was complicated because I had both guaranteed payments and capital contributions in my partnership. The tool identified that our operating agreement had contradictory language about loss allocations that would have caused problems in an audit. It also showed me how to document my "guaranteed payments" correctly to avoid them being reclassified. What I found most valuable was that it specifically identified IRS regulations that applied to my situation and explained them in plain English. Saved me hours of research and probably thousands in potential tax issues. Definitely not just generic advice like I was expecting.

Have you tried contacting the IRS directly about this? I spent THREE WEEKS trying to get someone on the phone when I had a similar issue with my family partnership. Finally discovered https://claimyr.com which got me through to an IRS agent in under 45 minutes! You can see how it works here: https://youtu.be/_kiP6q8DX5c The agent walked me through the exact regulations on partnership basis and explained that while service contributions don't create basis, there are options like being allocated partnership liabilities or structuring things as guaranteed payments that might help your situation. Definitely worth talking directly to the IRS rather than just relying on one CPA's opinion, especially when you're dealing with a technical issue like basis in partnerships.

So I was the skeptic who asked if Claimyr actually works - I decided to try it yesterday and I'm honestly shocked. After THREE MONTHS of trying to reach someone at the IRS about my partnership tax issue, I got through in 37 minutes. The IRS agent I spoke with was incredibly knowledgeable about partnership basis issues. She explained that while my service contributions don't create basis, my share of any partnership liabilities would give me basis. She also pointed me to specific IRS regulations that my CPA hadn't mentioned. I honestly wish I'd done this months ago instead of stressing. The agent even sent me follow-up documentation by mail to help with my filing. Sometimes it's worth paying for a solution when dealing with bureaucracy!

You might want to check Section 704(d) of the tax code. It specifically states that "A partner's distributive share of partnership loss (including capital loss) shall be allowed only to the extent of the adjusted basis of such partner's interest in the partnership at the end of the partnership year in which such loss occurred." In other words, without basis, you can't take the loss. However, you should look into whether you have any share of partnership liabilities that could give you basis. For example, if the business took out a loan that you're partially responsible for as a partner, that could give you basis even without contributing cash. Also worth noting - losses that exceed your basis aren't gone forever. They're suspended and can be used once you have sufficient basis in the future.

Your CPA is partially right but didn't give you the whole picture. Look into "special allocations" in partnerships. Section 704(b) of the tax code allows partnerships to allocate tax items differently than ownership percentages IF the allocation has "substantial economic effect." Maybe consider amending your operating agreement to formally recognize your sweat equity as equivalent to your partner's cash contributions? You could also adjust the agreement to get a larger share of future profits to compensate for not being able to use the losses now. And definitely get a second opinion from a different CPA! Not all accountants specialize in partnership taxation.

This is a frustrating but common situation in service-based partnerships. Your CPA is correct about the basis limitation - you need basis to deduct losses, and sweat equity unfortunately doesn't count under IRS rules. However, I notice from the thread that you mentioned having a $15,000 business loan that you're both named on. This is key! If you're personally liable for that debt (not just as an LLC member), your 50% share ($7,500) would give you basis to claim some of your allocated losses. Here's what I'd recommend: 1. Verify if you're personally liable for that loan - check if you signed personal guarantees 2. Get a second CPA opinion, preferably someone who specializes in partnership taxation 3. Review your operating agreement to see if it addresses loss allocations and partner liabilities 4. Consider if there are other partnership debts you might be liable for The suspended losses aren't lost forever - they'll carry forward until you have sufficient basis. And if you do have basis from the loan, you could potentially claim $7,500 of your allocated losses this year. Don't just take one CPA's word on this - partnership taxation is complex and many generalist accountants don't deal with it regularly.