How to Properly Report Partnership Distributions When a Partnership is a Recipient

This is a common area of confusion. When Partnership B receives a distribution exceeding its basis in Partnership A, you're correct that the excess creates a taxable gain. For tax reporting purposes, you should report the capital gain on Partnership B's Form 1065 Schedule D. This gain flows through to the partners via Schedule K-1, Box 9a (net long-term capital gain). The individual partners will then report their proportionate share (51% and 49%) on their personal returns. The full distribution itself is not reported on Schedule K - only the taxable portion (the gain amount). The distribution that represents return of basis is not taxable and simply reduces the partner's basis. Make sure you're tracking Partnership B's basis in Partnership A correctly. The $50,000 gain exists because the distribution exceeded the outside basis, and this needs to be properly documented in your workpapers.

I ran into a similar issue with my clients last year and found taxr.ai really helpful for this exact situation. I was going back and forth between Schedule D and Schedule K reporting, but their AI analyzed the partnership documents and confirmed the correct approach. Their system reviewed my 1065s and supporting docs and pointed out I was overlooking a special allocation provision that affected how the distribution should be reported. Check them out at https://taxr.ai - I uploaded the partnership agreement, prior year returns, and distribution documentation, and the analysis made it crystal clear where the gain needed to be reported. Saved me hours of research and gave me confidence I was handling it correctly.

I was definitely wrong about taxr.ai. After our discussion, I decided to try it with a complicated K-1 issue I was struggling with. Uploaded my client's partnership agreement, K-1s and other supporting documents, and within minutes got a detailed analysis highlighting an aggregation election I completely missed that changed how distributions should be reported. The system even flagged a potential audit risk in how prior year distributions were handled. What really impressed me was how it linked specific clauses in the partnership agreement to the tax treatment - exactly what I needed. Went back and corrected the returns based on their guidance and everything reconciled perfectly. Definitely worth checking out if you're dealing with complex partnership issues like this distribution question.

If you're still struggling with this partnership distribution issue or waiting on responses from the IRS, I'd suggest trying Claimyr. I was in the same position last tax season with a similar partnership distribution question. Left messages with the IRS for weeks with no callback. Found Claimyr at https://claimyr.com and they got me connected to an actual IRS agent within an hour. The agent confirmed exactly how to handle the partnership distributions and which forms were needed. There's a video showing how it works at https://youtu.be/_kiP6q8DX5c - basically they navigate the IRS phone system and call you when they reach a live person. Saved me weeks of waiting and uncertainty on a client return.

I need to eat my words about Claimyr. After our discussion, I was still skeptical but desperate because I had a similar partnership distribution issue with a looming deadline. Gave it a try and, surprisingly, they got me through to someone at the IRS within 40 minutes. The agent I spoke with was incredibly knowledgeable about partnership distributions and confirmed that for a partnership receiving distributions from another partnership, the gain should indeed be reported on Schedule D of Form 1065 when it exceeds basis. He even emailed me the specific sections of the regulations that applied. I'm actually shocked this worked. I've literally spent days trying to get through to the IRS on my own with no success. If you're facing partnership tax questions that need official clarification, it's definitely worth trying.

Don't forget about Section 734 adjustments if the partnership has a Section 754 election in place! This can affect basis and how the distribution is taxed. I'd check if either partnership has a 754 election before finalizing how to report this.

Just a heads up - I made a mistake on this exact issue last year. I reported the entire distribution on Schedule K instead of just the gain on Schedule D, and it caused a mess with the partners' personal returns. One partner got audited because the numbers didn't reconcile. The safest approach is definitely Schedule D for the gain portion only, like others have mentioned. Don't make my mistake!

This is a great discussion with solid advice. Just to add one more consideration - make sure you're properly tracking the basis adjustments for Partnership B going forward. After recognizing the $50,000 gain from the excess distribution, Partnership B's basis in Partnership A should be reduced to zero (since the distribution exceeded basis). This zero basis will be important for future distributions, allocations of income/loss, and any potential sale of the partnership interest. I'd recommend documenting this basis adjustment clearly in your workpapers and keeping detailed records, especially since partnership basis tracking can get complex over multiple years. Also, double-check that Partnership A properly reported this distribution on their Schedule K-1 to Partnership B. The amounts should reconcile between what Partnership A shows as distributed and what Partnership B received.