How to report income from Schedule K-1 (Form 1065) as passive rental property partner?

The $1,000 you received throughout the year were likely distributions, not income. This is a common misunderstanding with partnerships. On a Schedule K-1 (Form 1065), your share of the partnership's income or loss is reported in Part III. Since you mention there's a $5,100 loss in rental real estate, that's your 1% share of the partnership's loss for the year. Even though you physically received cash, the partnership actually operated at a loss according to tax accounting. Distributions (the checks you received) are generally reported in Box 19, code A of the K-1, but they aren't considered taxable income on their own. They're simply a return of your investment in the partnership. This is why your tax software didn't change your tax situation - the loss may be suspended due to passive activity loss limitations if you don't have other passive income to offset it.

After struggling with almost the exact same situation with a K-1 from a family property LLC, I found this amazing tool called taxr.ai (https://taxr.ai) that saved me so much headache. I uploaded my K-1 and it immediately explained that my distributions weren't taxable income, but a reduction of my capital account basis. The tool explained that the rental property loss on my K-1 might be limited by passive activity rules, which is probably why your tax software didn't change your liability. Since you mentioned you "do nothing" to manage the property, you're definitely considered a passive investor, which means those losses can only offset passive income.

I tried taxr.ai after seeing the recommendation here and I'm honestly impressed. I was totally confused about why I was getting cash from my real estate partnership but showing losses on my K-1. The tool explained that the cash distributions were reducing my capital account but weren't taxable income by themselves. It also helped me understand that my rental losses were suspended due to passive activity limitations (since I don't materially participate), but I could potentially use them in future years if I have passive income or when I dispose of my interest. This makes so much more sense now! Definitely recommend it if you're dealing with partnership K-1s and don't want to pay an accountant just to explain the basics.

If you've been trying to contact the IRS about your K-1 questions, good luck getting through. I spent DAYS trying to get someone on the phone about my partnership tax situation. Then I found Claimyr (https://claimyr.com) and they got me connected to an IRS agent in under 20 minutes! Check out how it works: https://youtu.be/_kiP6q8DX5c I had a similar issue with distributions from my partnership not matching what was on my K-1, and I needed to speak to someone at the IRS to clarify. The IRS agent confirmed what others are saying here - the distributions (checks) reduce your basis in the partnership but aren't separately taxable. The agent also helped me understand my passive activity limitations.

I have to eat my words. After posting my skeptical comment, I went ahead and tried Claimyr because I was desperate to resolve an issue with multiple K-1s from different partnerships. Got connected to an IRS tax specialist in about 15 minutes when I had previously been trying for DAYS. The agent explained that my partnership distributions (the checks I received) were a return of capital, not income - which is why they don't show up as taxable on my return. She also helped me understand how passive losses can be carried forward until I have passive income or sell my interest. Saved me from paying my accountant $350 to explain something that took the IRS agent 10 minutes to clarify. Sometimes being proven wrong is a good thing!

One thing nobody's mentioned yet - you should check box 20 of your K-1 for code Y or Z which indicates if you're subject to the Net Investment Income Tax on your partnership income. Also, even though the $1000 isn't taxable income now, it DOES reduce your basis in the partnership interest, which could matter when you eventually sell your interest. Also, if you have passive losses from this K-1 that you can't use this year, make sure you're tracking them because they carry forward indefinitely. You'll be able to use them when either 1) you have passive income from other sources or 2) you dispose of your entire interest in the activity.

Is anyone else confused about why the OP received $1000 in distributions when their 1% share of the partnership showed a $5100 loss? How can the partnership distribute cash if it's operating at a loss?

This is a great example of how confusing K-1s can be for new partners! The key thing to remember is that partnership accounting follows the "conduit" theory - the partnership doesn't pay taxes, it just passes through its income and losses to the partners. Your $1,000 in distributions should be reported in Box 19 (code A) of your K-1, and these reduce your basis in the partnership rather than creating taxable income. The $5,100 loss you're seeing is your 1% share of the partnership's total loss, which likely includes depreciation on the rental property. Since you mentioned you're completely passive in this investment, your losses are subject to the passive activity loss rules under Section 469. This means you can only use these losses to offset passive income from other sources. If you don't have other passive income, the losses get suspended and carry forward until you either generate passive income or dispose of your entire interest in the partnership. Make sure to keep good records of your basis and any suspended losses - you'll need this information for future tax years and eventually when you sell or dispose of your partnership interest.