Need clarification on Form 5471 Schedule P Part 2 - dollar basis calculation for 2023

The dollar basis in Schedule P Part 2 line 1a should indeed be carried over from your 2022 Schedule P Part 2 ending balance. You're on the right track! This represents the U.S. dollar amount of previously taxed E&P that you've already included in your gross income. What the instructions are trying to explain is that you need to maintain this dollar basis separately from the functional currency amounts in Part 1 because the dollar basis is used to calculate foreign currency gain/loss under section 986(c). If you were to convert the functional currency balances from Part 1 using the 2023 exchange rate, you'd lose track of the original dollar amounts that were previously taxed. The whole point of Schedule P Part 2 is to track your basis in previously taxed E&P in U.S. dollars, which allows you to properly calculate currency gain/loss when distributions are made from the foreign corporation.

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I ran into this exact issue last year. Here's what my CPA explained to me: the dollar basis in Schedule P Part 2 needs to track the actual dollar amounts that were included in your income in previous years. Think of it like your basis in a stock - you need to know what you paid (in dollars) to calculate your gain when you sell. Similarly, you need to know what amounts were included in your income (in dollars) to calculate currency gain/loss when you receive distributions. If you converted the functional currency to dollars using the current year rate, you'd be creating an artificial basis amount that doesn't reflect what was actually included in your income. Hope that helps!

Does anyone know if there's a way to recreate the Schedule P Part 2 if you didn't properly track this in prior years? I've got functional currency amounts but never maintained the separate dollar basis tracking until now.

I've been dealing with Form 5471 for several years now and can confirm what others have said - you absolutely need to carry forward the dollar basis amounts from your 2022 Schedule P Part 2 ending balance to your 2023 beginning balance. Don't convert using 2023 rates. One thing I haven't seen mentioned yet is that you should also make sure you're properly categorizing any new 2023 inclusions by the correct PTEP category (Section 951(a), Section 951A, etc.) when you add them to your basis amounts. Each category needs to be tracked separately because they have different distribution ordering rules. Also, if you had any actual distributions during 2023, make sure you're reducing your basis amounts in the proper LIFO order and calculating the Section 986(c) gain/loss on the difference between your dollar basis and the dollar value of the distribution. This is where a lot of people mess up the currency calculations.