Capital Accounts: 704(b) vs. GAAP vs. Tax Basis, Comparing and Contrasting Annual Allocations (2024)

FAQs

Capital Accounts: 704(b) vs. GAAP vs. Tax Basis, Comparing and Contrasting Annual Allocations? ›

Section 704(b) accounts reflect a partner's economic interest in the entity, GAAP balances report balances that comply with accounting board requirements, and tax basis balances reflect a partner's capital balance under federal income tax principles.

Your 704(b) capital account tends to govern the economics of your arrangement with your partners (and also determines whether allocations meet the “substantial economic effect” test), while the tax basis amount governs how much gain you have for income tax purposes.

Under GAAP, businesses report revenues, expenses and net income. Tax-basis entities report gross income, deductions and taxable income. Their nontaxable items typically appear as separate line items or are disclosed in a footnote.

A partner's capital account and outside basis are not the same. The partner's "capital account" measures the partner's equity investment in the partnership. The "outside basis" measures the adjusted basis of the partner's partnership interest.

The tax-adjusted basis is calculated by taking the original cost or other basis of the asset in question and adjusting it for various tax-related allowances such as depreciation. Book-adjusted basis is a measure of what an asset is worth from a company's perspective on its books.

Section 704(b) has very detailed regulations to protect the integrity of agreed-to allocations. These regulations contain various safe harbor provisions that may be included in a partnership agreement. Allocations that follow one or more of these safe harbors may be called regulatory allocations.

A partner's distributive share of income, gain, loss, deduction, or credit (or item thereof) shall be determined in accordance with the partner's interest in the partnership (determined by taking into account all facts and circ*mstances), if—

A cash basis taxpayer reports income when it is actually received, and reports expenses when they are paid. The majority of people who file individual income tax returns are cash basis taxpayers. Accrual basis taxpayers compute income when they actually earn it or became entitled to it.

Here is a quick overview of the key differences: Cash basis recognizes revenue and expenses when the cash is actually received or paid out. Tax basis can use either cash or accrual methods for recognizing revenue and expenses.

Accrual basis accounting is the only option allowed under GAAP. Tax accounting can use cash, accrual or modified basis accounting.

Is capital the same as basis? ›

Basis is generally the amount of your capital investment in property for tax purposes. Use your basis to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange, or other disposition of the property.

The tax basis method is a transactional approach. Since this approach is based on tax basis principles, each contribution or partnership net income increases a partner's capital account, and each distribution or shares of loss decrease the capital account.

Example of a capital account

If the business is a limited company or LLP, the amount of profit made by the business in previous years that has not yet been paid out to the shareholders or members is also a capital account - because it is money that could theoretically be taken out by the owners.

It is common that cash basis accounting is used by small businesses whereas traditional accounting is used by larger businesses. At Tax Care, we offer services to help with your accounting whether you are a small business or large.

The basis of accounting refers to the timing varieties when financial events get recorded. The two main types of bases are cash basis and accrual basis accounting. Cash basis records finances when money exchanges hands, while accrual basis when the transaction occurs, whether or not any cash has been received or paid.

The Tax Basis Balance Sheet can be used to enter adjustments and the actual tax basis of assets/liabilities based on the return as filed.

The tax basis method is a transactional approach. Since this approach is based on tax basis principles, each contribution or partnership net income increases a partner's capital account, and each distribution or shares of loss decrease the capital account.

The built-in loss on section 704(c) property is the excess of the contributing partner's adjusted tax basis over the property's book value upon contribution. The built-in loss is thereafter reduced by decreases in the difference between the property's adjusted tax basis and book value.

In most situations, the basis of an asset is its cost to you. The cost is the amount you pay for it in cash, debt obligations, and other property or services. Cost includes sales tax and other expenses connected with the purchase.

The four major types of capital include working capital, debt, equity, and trading capital. Trading capital is used by brokerages and other financial institutions.