US Internal Revenue Service: i1065--1999

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1999 Department of the TreasuryInternal Revenue ServiceInstructions for Form 1065U.S. Partnership Return of IncomeSection references are to the Internal Revenue Code unless otherwise noted.

Paperwork Reduction Act Notice. We ask for the information on this form to carryout the Internal Revenue laws of the United States. You are required to give us theinformation. We need it to ensure that you are complying with these laws and to allowus to figure and collect the right amount of tax.

You are not required to provide the information requested on a form that is subjectto the Paperwork Reduction Act unless the form displays a valid OMB control number.Books or records relating to a form or its instructions must be retained as long as theircontents may become material in the administration of any Internal Revenue law.Generally, tax returns and return information are confidential, as required by section6103.

The time needed to complete and file this form and related schedules will varydepending on individual circumstances. The estimated average times are:

If you have comments concerning the accuracy of these time estimates orsuggestions for making these forms simpler, we would be happy to hear from you. Youcan write to the Tax Forms Committee, Western Area Distribution Center, Rancho

Cordova, CA 95743-0001. DO NOT send the tax form to this address. Instead, seeWhere To File on page 4.

Pending LegislationAt the time of printing, Congress wasconsidering legislation affecting theseinstructions. Included in the pendinglegislation are provisions that wouldchange the definition of a capital asset,modify the treatment of gains from

constructive ownership transactions,repeal the use of the installment methodfor certain taxpayers, and limit the use ofthe nonaccrual experience method ofaccounting. See Pub. 553, Highlights of1999 Tax Changes, to find out if thislegislation was enacted, and details onthe changes.

Changes To Note

q For tax years ending on or afterDecember 31, 1999, partnerships are nolonger able to submit their returns on

Contents Page

Schedules K and K-1Partners'Shares of Income, Credits,Deductions, etc. . . . . . . . . . 18

Purpose of Schedules . . . . . . 18

Substitute Forms . . . . . . . . . 19

How Income is Shared AmongPartners . . . . . . . . . . . . . 19

Specific Instructions (Schedule K-1Only) . . . . . . . . . . . . . . . 19

General Information . . . . . . . . 19

Specific Items and Questions . . . 19

Form Recordkeeping

Learning about the

law or the form Preparing the form

Copying,assembling,

and sending theform

to the IRS

Specific Instructions (Schedules Kand K-1, Except as Noted) . . . 20

Special Allocations . . . . . . . . 201065 39 hr., 50 min. 21 hr., 28 min. 37 hr., 11 min. 4 hr., 1 min.

Income (Loss) . . . . . . . . . . . 20Schedule D(Form 1065) 6 hr., 56 min. 1 hr., 35 min. 1 hr., 47 min. Deductions . . . . . . . . . . . . 21

Credits . . . . . . . . . . . . . . 22Schedule K-1(Form 1065) 25 hr., 7 min. 9 hr., 20 min. 10 hr., 10 min. Investment Interest . . . . . . . . 23Schedule L(Form 1065) 15 hr., 32 min. 6 min. 22 min. Self-Employment . . . . . . . . . 23

Adjustments and Tax PreferenceItems . . . . . . . . . . . . . . 24

Schedule M-1(Form 1065) 3 hr., 21 min. 12 min. 16 min.

Foreign Taxes . . . . . . . . . . 26Schedule M-2(Form 1065) 2 hr., 52 min. 6 min. 9 min.

Other . . . . . . . . . . . . . . . 26

Analysis of Net Income (Loss) . . . 28

Schedule LBalance Sheets . . . . 29

Schedule M-1Reconciliation ofIncome (Loss) per Books WithIncome (Loss) per Return . . . . 29

Schedule M-2Analysis of Partners'Capital Accounts . . . . . . . . . 29Contents PageContents Page

Other Forms That May Be Required 5Pending Legislation . . . . . . . . . 1 Codes for Principal Business Activityand Principal Product or Service . 30Attachments . . . . . . . . . . . . 7Changes To Note . . . . . . . . . . 1

Separately Stated Items . . . . . 7Photographs of Missing Children . . 2Elections Made by the Partnership 7

Unresolved Tax Problems . . . . . 2Elections Made by Each Partner . 7

How To Get Forms and Publications 2Partner's Dealings With Partnership 7

General Instructions . . . . . . . . 2Contributions to the Partnership . 7

Purpose of Form . . . . . . . . . 2 Dispositions of Contributed Property 8Definitions . . . . . . . . . . . . . 2 Recognition of Precontribution Gain

on Certain Partnership Distributions 8Who Must File . . . . . . . . . . 3

Termination of the Partnership . . 3 Unrealized Receivables and InventoryItems . . . . . . . . . . . . . . 8Electronic Filing . . . . . . . . . . 3

When To File . . . . . . . . . . . 3 Passive Activity Limitations . . . . 8

Where To File . . . . . . . . . . . 4 Specific Instructions . . . . . . . 12Who Must Sign . . . . . . . . . . 4 General Information . . . . . . . . 12Penalties . . . . . . . . . . . . . 4 Income . . . . . . . . . . . . . . 13Accounting Methods . . . . . . . 4 Deductions . . . . . . . . . . . . 14Accounting Periods . . . . . . . . 5 Schedule ACost of Goods Sold . 17Rounding Off to Whole Dollars . . 5 Schedule BOther Information . . . 17Recordkeeping . . . . . . . . . . 5

Designation of Tax Matters Partner . 18Amended Return . . . . . . . . . 5

Cat. No. 11392V


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magnetic tape or diskette, or use theRemote Bulletin Board System or the dialup MITRON communications device totransmit their returns electronically. Inaddition, the Paper-Parent Optionmethod of filing partnership returns is nolonger available. However, qualifiedpartnerships or transmitters can file Form1065, U.S. Partnership Return of Income,Schedules K-1, and related forms andschedules electronically. For additionalinformation, see Electronic Filing on

page 3.q For tax years beginning in 1999, therequirement under section 6011(e) forpartnerships with more than 100 partnersto file electronically will not apply.

Photographs of MissingChildrenThe Internal Revenue Service is a proudpartner with the National Center forMissing and Exploited Children.Photographs of missing children selectedby the Center may appear in instructionson pages that would otherwise be blank.

You can help bring these children homeby looking at the photographs and calling1-800-THE-LOST (1-800-843-5678) if yourecognize a child.

Unresolved Tax ProblemsMost problems can be resolved with onecontact by calling, writing, or visiting anIRS office. But if the partnership has triedunsuccessfully to resolve a problem withthe IRS, it should contact the TaxpayerAdvocate's office. The partnership will beassigned a personal advocate who is inthe best position to try to resolve theproblem.

Contact the Taxpayer Advocate if thepartnership:q Is suffering or about to suffer asignificant hardship.q Is facing an immediate threat ofadverse action.q Will incur significant costs if relief is notgranted (including fees for professionalrepresentation).q Will suffer irreparable injury orlong-term adverse impact if relief is notgranted.q Has experienced a delay of more than30 calendar days to resolve a tax problemor inquiry.

q Has not received a response orresolution to the problem by the datepromised.

The partnership may contact aTaxpayer Advocate by calling a toll-freeassistance number,1-877-777-4778.Persons who have access to TTY/TDDequipment may call 1-800-829-4059 andask for the Taxpayer Advocate. If thepartnership prefers, it may write to theTaxpayer Advocate at the IRS office thatlast contacted the partnership.

While Taxpayer Advocates cannotchange the tax law or make a technicaltax decision, they can clear up problemsthat resulted from previous contacts andensure that the partnership's case is givena complete and impartial review. Formore information about the TaxpayerAdvocate, see Pub. 1546, The TaxpayerAdvocate Service of the IRS.

How To Get Forms and

PublicationsPersonal Computer

You can access the IRS's Internet WebSite 24 hours a day, 7 days a week atwww.irs.gov to:q Download forms, instructions, andpublications.q See answers to frequently asked taxquestions.q Search publications on-line by topic orkeyword.q Send us comments or request help bye-mail.q Sign up to receive local and national tax

news by e-mail.You can also reach us using file

transfer protocol at ftp.irs.gov.

CD-ROM

Order Pub. 1796, Federal Tax Productson CD-ROM, and get:q Current year forms, instructions, andpublications.q Prior year forms, instructions, andpublications.q Popular tax forms that may be filled inelectronically, printed out for submission,and saved for recordkeeping.q

The Internal Revenue Bulletin.Buy the CD-ROM on the Internet atwww.irs.gov/cdorders from the NationalTechnical Information Service (NTIS) for$16 (plus a $5 handling fee) and save30%, or call 1-877-CDFORMS(1-877-233-6767) toll free to buy theCD-ROM for $23 (plus a $5 handling fee).

By Phone and In Person

You can order forms and publications 24hours a day, 7 days a week, by calling1-800-TAX-FORM (1-800-829-3676). Youcan also get most forms and publicationsat your local IRS office.

General Instructions

Purpose of FormForm 1065 is an information return usedto report the income, deductions, gains,losses, etc., from the operation of apartnership. A partnership does not paytax on its income but passes throughany profits or losses to its partners.Partners must include partnership itemson their tax returns.

Definitions

Partnership

A partnership is the relationship betweentwo or more persons who join to carry ona trade or business, with each personcontributing money, property, labor, orskill and each expecting to share in theprofits and losses of the business whetheror not a formal partnership agreement ismade.

The term partnership includes alimited partnership, syndicate, group,pool, joint venture, or otherunincorporated organization, through orby which any business, financialoperation, or venture is carried on, that isnot, within the meaning of the regulationsunder section 7701, a corporation, trust,estate, or sole proprietorship.

A joint undertaking merely to shareexpenses is not a partnership. Mereco-ownership of property that ismaintained and leased or rented is not apartnership. However, if the co-ownersprovide services to the tenants, a

partnership exists.General Partner

A general partner is a partner who ispersonally liable for partnership debts.

General Partnership

A general partnership is composed onlyof general partners.

Limited Partner

A limited partner is a partner in apartnership formed under a state limitedpartnership law, whose personal liabilityfor partnership debts is limited to theamount of money or other property that

the partner contributed or is required tocontribute to the partnership. Somemembers of other entities, such asdomestic or foreign business trusts orlimited liability companies that areclassified as partnerships, may be treatedas limited partners for certain purposes.See, for example, Temporary Regulationssection 1.469-5T(e)(3), which treats allmembers with limited liability as limitedpartners for purposes of section469(h)(2).

Limited Partnership

A limited partnership is formed under astate limited partnership law andcomposed of at least one general partnerand one or more limited partners.

Limited Liability Partnership

A limited liability partnership (LLP) isformed under a state limited liabilitypartnership law. Generally, a partner inan LLP is not personally liable for thedebts of the LLP or any other partner, noris a partner liable for the acts or omissionsof any other partner, solely by reason ofbeing a partner.

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Limited Liability Company

A limited liability company (LLC) is anentity formed under state law by filingarticles of organization as an LLC. Unlikea partnership, none of the members of anLLC are personally liable for its debts. AnLLC may be classified for Federal incometax purposes either as a partnership, acorporation, or an entity disregarded asan entity separate from its owner byapplying the rules in Regulations section

301.7701-3. See Form 8832, EntityClassification Election, for more details.

Nonrecourse Loans

Nonrecourse loans are those liabilities ofthe partnership for which no partner bearsthe economic risk of loss.

Who Must FileExcept as provided below, every domesticpartnership must file Form 1065, unlessit neither receives income nor incurs anyexpenditures treated as deductions orcredits for Federal income tax purposes.

A foreign partnership that engages in a

trade or business within the United Statesor has gross income derived from sourcesin the United States must file Form 1065,even if its principal place of business isoutside the United States or all itsmembers are nonresident aliens.

Entities formed as LLCs and treated aspartnerships for Federal income taxpurposes must file Form 1065.

A religious or apostolic organizationexempt from income tax under section501(d) must file Form 1065 to report itstaxable income, which must be allocatedto its members as a dividend, whetherdistributed or not. Such an organizationmust figure its taxable income on anattachment to Form 1065 in the samemanner as a corporation. Theorganization may use Form 1120, U.S.Corporation Income Tax Return, for thispurpose. Enter the organization's taxableincome, if any, on line 4b of Schedule Kand each member's pro rata share on line4b of Schedule K-1. Net operating lossesare not deductible by the members butmay be carried back or forward by theorganization under the rules of section172. The religious or apostolicorganization also must make its annualinformation return available for publicinspection. For this purpose, annual

information return includes an exact copyof Form 1065 and all accompanyingschedules and attachments, exceptSchedules K-1. For more details, seeRegulations section 301.6104(d)-3.

A qualifying syndicate, pool, jointventure, or similar organization may electunder section 761(a) not to be treated asa partnership for Federal income taxpurposes and will not be required to fileForm 1065 except for the year of election.For details, see section 761(a) andRegulations section 1.761-2.

Note: Investment clubs, by unanimousconsent of their members, qualify to makethis election provided the members cancompute their income from the activitywithout the necessity of computingpartnership income.

An electing large partnership (asdefined in section 775) must file Form1065-B, U.S. Return of Income forElecting Large Partnerships.

Real estate mortgage investmentconduits (REMICs) must file Form 1066,U.S. Real Estate Mortgage InvestmentConduit (REMIC) Income Tax Return.

Certain publicly traded partnershipstreated as corporations under section7704 must file Form 1120.

Termination of thePartnershipA partnership terminates when:

1. All its operations are discontinuedand no part of any business, financialoperation, or venture is continued by anyof its partners in a partnership, or

2. At least 50% of the total interest inpartnership capital and profits is sold orexchanged within a 12-month period,including a sale or exchange to anotherpartner. See Regulations section1.708-1(b)(1) for more details.

The partnership's tax year ends on thedate of termination. For purposes of 1above, the date of termination is the datethe partnership winds up its affairs. Forpurposes of 2 above, the date oftermination is the date the partnershipinterest is sold or exchanged that, of itselfor together with other sales or exchangesin the preceding 12 months, transfers aninterest of 50% or more in both

partnership capital and profits.Special rules apply in the case of a

merger, consolidation, or division of apartnership. See Regulations section1.708-1(b)(2) for details.

Electronic FilingBeginning March 15, 2000, qualifiedpartnerships or transmitters can file Form1065, Schedules K-1, and related formsand schedules electronically.

To file electronically, partnershipsmust file:

q Form 9041, Application for

Electronic/Magnetic Media Filing ofBusiness and Employee Benefit PlanReturns, andq Form 8453P, U.S. PartnershipDeclaration and Signature for ElectronicFiling.

For more details on electronicfiling, see:

q Pub. 1524, Procedures andSpecifications for Electronic Filing of Form1065, U.S. Partnership Return of Income,for Tax Year 1999;

q Pub. 1525, Validation Criteria andRecord Layouts for Electronic Filing ofForm 1065, U.S. Partnership Return ofIncome, for Tax Year 1999;q Pub. 3416, Electronic Filing of Form1065 (Publication 1525 Supplement) forTax Year 1999; andq Pub. 3225, Test Package for ElectronicFilers of U.S. Partnership Return ofIncome, for Tax Year 1999.

To order these forms andpublications, or for moreinformation on filing electronically:

q Call the Electronic Filing Section at theMemphis Service Center at 901-546-2690(not a toll-free call), orq Write to Internal Revenue ServiceCenter, Electronic Filing Section, Stop 26,P.O. Box 30309, Memphis, TN 38130.

When To FileGenerally, a domestic partnership mustfile Form 1065 by the 15th day of the 4thmonth following the date its tax yearended as shown at the top of Form 1065.

A partnership whose partners are allnonresident aliens must file its return bythe 15th day of the 6th month followingthe date its tax year ended. If the due datefalls on a Saturday, Sunday, or legalholiday, file on the next business day.

Private Delivery Services

You can use certain private deliveryservices designated by the IRS to meetthe timely mailing as timely filing/payingrule for Form 1065. The most recent listof designated private delivery serviceswas published by the IRS in August 1999.The list includes only the following:q

Airborne Express (Airborne): OvernightAir Express Service, Next AfternoonService, Second Day Service.q DHL Worldwide Express (DHL): DHLSame Day Service, DHL USAOvernight.q Federal Express (FedEx): FedExPriority Overnight, FedEx StandardOvernight, FedEx 2Day.q United Parcel Service (UPS): UPS NextDay Air, UPS Next Day Air Saver, UPS2nd Day Air, UPS 2nd Day Air A.M.

The private delivery service can tell youhow to get written proof of the mailingdate.

Extension

If you need more time to file a partnershipreturn, file Form 8736, Application forAutomatic Extension of Time To File U.S.Return for a Partnership, REMIC, or forCertain Trusts, for an automatic 3-monthextension. File Form 8736 by the regulardue date of the partnership return.

If, after you have filed Form 8736, youstill need more time to file the partnershipreturn, file Form 8800, Application forAdditional Extension of Time To File U.S.Return for a Partnership, REMIC, or for

Instructions for Form 1065 Page 3


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Certain Trusts, for an additional extensionof up to 3 months. The partnership mustshow reasonable cause to get thisadditional extension. Form 8800 must befiled by the extended due date of thepartnership return.

Period Covered

Form 1065 is an information return forcalendar year 1999 and fiscal yearsbeginning in 1999 and ending in 2000. Ifthe return is for a fiscal year or a short tax

year, fill in the tax year space at the topof the form.

The 1999 Form 1065 may also be usedif:

1. The partnership has a tax year ofless than 12 months that begins and endsin 2000; and

2. The 2000 Form 1065 is notavailable by the time the partnership isrequired to file its return.

However, the partnership must show its2000 tax year on the 1999 Form 1065 andincorporate any tax law changes that areeffective for tax years beginning after1999.

Where To FileFile Form 1065 at the applicable IRSaddress listed below.

A partnership without a principal officeor agency or principal place of businessin the United States must file its returnwith the Internal Revenue Service Center,Philadelphia, PA 19255-0011.

Who Must Sign

General Partner or LLC Member

Form 1065 is not considered to be areturn unless it is signed. One generalpartner or LLC member must sign thereturn. If a receiver, trustee in bankruptcy,or assignee controls the organization'sproperty or business, that person mustsign the return.

Paid Preparer's Information

If someone prepares the return and doesnot charge the partnership, that person

should not sign the partnership return.Generally, anyone who is paid toprepare the partnership return must:q Sign the return, by hand, in the spaceprovided for the preparer's signature.Signature stamps or labels are notacceptable.q Fill in the other blanks in the PaidPreparer's Use Only area of the return.q Give the partnership a copy of thereturn in addition to the copy to be filedwith the IRS.

Penalties

Late Filing of ReturnA penalty is assessed against thepartnership if it is required to file apartnership return and it (a) fails to file thereturn by the due date, includingextensions, or (b) files a return that failsto show all the information required,unless such failure is due to reasonablecause. If the failure is due to reasonablecause, attach an explanation to thepartnership return. The penalty is $50 foreach month or part of a month (for amaximum of 5 months) the failurecontinues, multiplied by the total numberof persons who were partners in thepartnership during any part of thepartnership's tax year for which the returnis due. This penalty will not be imposedon partnerships for which the answer toQuestion 4 on Schedule B of Form 1065is No, provided all partners have timelyfiled income tax returns fully reportingtheir shares of the income, deductions,and credits of the partnership. See page18 of the instructions for furtherinformation.

Failure To Furnish InformationTimely

For each failure to furnish Schedule K-1to a partner when due and each failure toinclude on Schedule K-1 all theinformation required to be shown (or theinclusion of incorrect information), a $50penalty may be imposed with respect toeach Schedule K-1 for which a failureoccurs. The maximum penalty is$100,000 for all such failures during a

calendar year. If the requirement to reportcorrect information is intentionallydisregarded, each $50 penalty isincreased to $100 or, if greater, 10% ofthe aggregate amount of items requiredto be reported, and the $100,000maximum does not apply.

Trust Fund Recovery Penalty

This penalty may apply if certain excise,income, social security, and Medicaretaxes that must be collected or withheldare not collected or withheld, or thesetaxes are not paid. These taxes aregenerally reported on:q Form 720, Quarterly Federal ExciseTax Return;q Form 941, Employer's QuarterlyFederal Tax Return;q Form 943, Employer's Annual TaxReturn for Agricultural Employees; orq Form 945, Annual Return of WithheldFederal Income Tax.

The trust fund recovery penalty maybe imposed on all persons who aredetermined by the IRS to have beenresponsible for collecting, accounting for,and paying over these taxes, and whoacted willfully in not doing so. The penaltyis equal to the unpaid trust fund tax. Seethe Instructions for Form 720, Pub. 15,Circular E, Employer's Tax Guide, or Pub.51, Circular A, Agricultural Employer'sTax Guide, for more details, including thedefinition of a responsible person.

Accounting MethodsFigure ordinary income using the methodof accounting regularly used in keepingthe partnership's books and records.Generally, permissible methods includethe cash method, the accrual method, orany other method authorized by theInternal Revenue Code. In all cases, themethod used must clearly reflect income.

Generally, a partnership may not usethe cash method of accounting if (a) it hasat least one corporate partner, averageannual gross receipts of more than $5million, and it is not a farming businessor (b) it is a tax shelter (as defined insection 448(d)(3)). See section 448 fordetails.

Under the accrual method, an amountis includible in income when all the eventshave occurred that fix the right to receivethe income and the amount can bedetermined with reasonable accuracy.

Alabama, Arkansas,Louisiana, Mississippi, NorthCarolina, Tennessee

Memphis, TN37501-0011

Delaware, District ofColumbia, Maryland,Pennsylvania, Virginia

Philadelphia, PA19255-0011

If the partnership'sprincipal business,office, or agency is

located in

Use the followingInternal Revenue

Service Center address

New Jersey, New York (NewYork City and counties ofNassau, Rockland, Suffolk,and Westchester)

Holtsville, NY00501-0011

New York (all other

counties), Connecticut,Maine, Massachusetts, NewHampshire, Rhode Island,Vermont

Andover, MA05501-0011

Florida, Georgia, SouthCarolina

Atlanta, GA39901-0011

Indiana, Kentucky, Michigan,Ohio, West Virginia

Cincinnati, OH45999-0011

Kansas, New Mexico,Oklahoma, Texas

Austin, TX73301-0011

Alaska, Arizona, California(counties of Alpine, Amador,Butte, Calaveras, Colusa,Contra Costa, Del Norte, ElDorado, Glenn, Humboldt,Lake, Lassen, Marin,Mendocino, Modoc, Napa,

Nevada, Placer, Plumas,Sacramento, San Joaquin,Shasta, Sierra, Siskiyou,Solano, Sonoma, Sutter,Tehama, Trinity, Yolo, andYuba), Colorado, Idaho,Montana, Nebraska, Nevada,North Dakota, Oregon, SouthDakota, Utah, Washington,Wyoming

Ogden, UT84201-0011

California (all other counties),Hawaii

Fresno, CA93888-0011

Illinois, Iowa, Minnesota,Missouri, Wisconsin

Kansas City, MO64999-0011



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Generally, an accrual basis taxpayercan deduct accrued expenses in the taxyear in which:q All events that determine liability haveoccurred,q The amount of the liability can befigured with reasonable accuracy, andq Economic performance takes place withrespect to the expense. There areexceptions for certain items, includingrecurring expenses.

Except for certain home constructioncontracts and other real property smallconstruction contracts, long-termcontracts must generally be accounted forusing the percentage of completionmethod described in section 460.

Generally, the partnership may changeits method of accounting used to reportincome (for income as a whole or for anymaterial item) only by getting consent onForm 3115, Application for Change inAccounting Method. For more information,see Pub. 538, Accounting Periods andMethods.

Mark-to-Market Accounting Method

Dealers in securities must use themark-to-market accounting methoddescribed in section 475. Under thismethod, any security that is inventory tothe dealer must be included in inventoryat its fair market value (FMV). Anysecurity that is not inventory and that isheld at the close of the tax year is treatedas sold at its FMV on the last businessday of the tax year, and any gain or lossmust be taken into account in determininggross income. The gain or loss taken intoaccount is generally treated as ordinarygain or loss. For details, includingexceptions, see section 475 and the

related regulations.Dealers in commodities and traders insecurities and commodities may elect touse the mark-to-market accountingmethod. To make the election for taxyears beginning after 1998, thepartnership must file a statementdescribing the election, the first tax yearthe election is to be effective, and, in thecase of an election for traders in securitiesor commodities, the trade or business forwhich the election is made. Except fornew taxpayers, the statement must befiled by the due date (not includingextensions) of the income tax return forthe tax year immediately preceding the

election year and attached to that return,or, if applicable, to a request for anextension of time to file that return. Formore details, see Rev. Proc. 99-17,1999-7 I.R.B. 52, and sections 475(e) and(f).

Accounting PeriodsA partnership is generally required tohave one of the following tax years:

1. The tax year of a majority of itspartners (majority tax year).

2. If there is no majority tax year, thenthe tax year common to all of thepartnership's principal partners (partnerswith an interest of 5% or more in thepartnership profits or capital).

3. If there is neither a majority tax yearnor a tax year common to all principalpartners, then the tax year that results inthe least aggregate deferral of income.

4. Some other tax year, if:q The partnership can establish that there

is a business purpose for the tax year(see Rev. Proc. 87-32, 1987-2 C.B. 396);orq The tax year is a grandfathered year(see Rev. Proc. 87-32); orq The partnership elects under section444 to have a tax year other than arequired tax year by filing Form 8716,Election to Have a Tax Year Other Thana Required Tax Year. For a partnershipto have this election in effect, it mustmake the payments required by section7519 and file Form 8752, RequiredPayment or Refund Under Section 7519.

A section 444 election ends if a

partnership changes its accounting periodto its required tax year or some otherpermitted year or it is penalized forwillfully failing to comply with therequirements of section 7519. If thetermination results in a short tax year,type or legibly print at the top of the firstpage of Form 1065 for the short tax year,SECTION 444 ELECTIONTERMINATED.

To change an accounting period, seePub. 538 and Form 1128, Application ToAdopt, Change, or Retain a Tax Year,(unless the partnership is making anelection under section 444).

Note: Under the provisions of section584(h), the tax year of a common trustfund must be the calendar year.

Rounding Off to WholeDollarsYou may round off cents to whole dollarson your return and accompanyingschedules. To do so, drop amounts under50 cents and increase amounts from 50to 99 cents to the next higher dollar.

RecordkeepingThe partnership must keep its records aslong as they may be needed for the

administration of any provision of theInternal Revenue Code. If theconsolidated audit procedures of sections6221 through 6233 apply, the partnershipusually must keep records that supportan item of income, deduction, or credit onthe partnership return for 3 years from thedate the return is due or is filed,whichever is later. If the consolidatedaudit procedures do not apply, theserecords usually must be kept for 3 yearsfrom the date each partner's return is dueor is filed, whichever is later. Keep

records that verify the partnership's basisin property for as long as they are neededto figure the basis of the original orreplacement property.

The partnership should also keepcopies of all returns it has filed. They helpin preparing future returns and in makingcomputations when filing an amendedreturn.

Amended Return

To correct an error on a Form 1065already filed, file an amended Form 1065and check box G(4) on page 1. If theincome, deductions, credits, or otherinformation provided to any partner onSchedule K-1 are incorrect, file anamended Schedule K-1 (Form 1065) forthat partner with the amended Form 1065.Also give a copy of the amendedSchedule K-1 to that partner. Check boxI(2) on the Schedule K-1 to indicate thatit is an amended Schedule K-1.

Exception: If you are filing an amendedpartnership return and you answeredYesto Question 4 in Schedule B, the taxmatters partner must fileForm 8082,Notice of Inconsistent Treatment orAdministrative Adjustment Request(AAR).

A change to the partnership's Federalreturn may affect its state return. Thisincludes changes made as a result of anexamination of the partnership return bythe IRS. For more information, contactthe state tax agency for the state in whichthe partnership return is filed.

Other Forms That May BeRequired

q Forms W-2 and W-3, Wage and Tax

Statement; and Transmittal of Wage andTax Statements.q Form 720, Quarterly Federal ExciseTax Return. Use Form 720 to reportenvironmental excise taxes,communications and air transportationtaxes, fuel taxes, luxury tax on passengervehicles, manufacturers' taxes, shippassenger tax, and certain other excisetaxes.

Caution: SeeTrust Fund RecoveryPenaltyon page 4.q Form 926, Return by a U.S. Transferorof Property to a Foreign Corporation. Usethis form to report certain information

required under section 6038B.q Form 940 or Form 940-EZ, Employer'sAnnual Federal Unemployment (FUTA)Tax Return. The partnership may be liablefor FUTA tax and may have to file Form940 or 940-EZ if it paid wages of $1,500or more in any calendar quarter during thecalendar year (or the preceding calendaryear) or one or more employees workedfor the partnership for some part of a dayin any 20 different weeks during thecalendar year (or the preceding calendaryear).



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q Form 941, Employer's QuarterlyFederal Tax Return. Employers must filethis form quarterly to report income taxwithheld on wages and employer andemployee social security and Medicaretaxes. Agricultural employers must fileForm 943, Employer's Annual Tax Returnfor Agricultural Employees, instead ofForm 941, to report income tax withheldand employer and employee socialsecurity and Medicare taxes onfarmworkers.

Caution: SeeTrust Fund RecoveryPenaltyon page 4.q Form 945, Annual Return of WithheldFederal Income Tax. Use this form toreport income tax withheld fromnonpayroll payments, including pensions,annuities, individual retirement accounts(IRAs), gambling winnings, and backupwithholding.

Caution: SeeTrust Fund RecoveryPenaltyon page 4.q Forms 1042 and 1042-S, AnnualWithholding Tax Return for U.S. SourceIncome of Foreign Persons; and ForeignPerson's U.S. Source Income Subject to

Withholding. Use these forms to reportand send withheld tax on payments ordistributions made to nonresident alienindividuals, foreign partnerships, orforeign corporations to the extent suchpayments or distributions constitute grossincome from sources within the UnitedStates that is not effectively connectedwith a U.S. trade or business. A domesticpartnership must also withhold tax on aforeign partner's distributive share of suchincome, including amounts that are notactually distributed. Withholding onamounts not previously distributed to aforeign partner must be made and paidover by the earlier of (a) the date on whichSchedule K-1 is sent to that partner or (b)the 15th day of the 3rd month after theend of the partnership's tax year. Formore information, see sections 1441 and1442 and Pub. 515, Withholding of Taxon Nonresident Aliens and ForeignCorporations.q Form 1096, Annual Summary andTransmittal of U.S. Information Returns.q Form 1098, Mortgage InterestStatement. Use this form to report thereceipt from any individual of $600 ormore of mortgage interest and points inthe course of the partnership's trade orbusiness for any calendar year.

q Forms 1099-A, B, INT, LTC, MISC,MSA, OID, R, and S. You may have to filethese information returns to reportacquisitions or abandonments of securedproperty; proceeds from broker and barterexchange transactions; interestpayments; payments of long-term careand accelerated death benefits;miscellaneous income payments;distributions from a medical savingsaccount (MSA); original issue discount;distributions from pensions, annuities,retirement or profit-sharing plans, IRAs,

insurance contracts, etc.; and proceedsfrom real estate transactions. Also, usecertain of these returns to report amountsthat were received as a nominee onbehalf of another person.

For more information, see theInstructions for Forms 1099, 1098, 5498,and W-2G.

Important: Every partnership must fileForms 1099-MISC if, in the course of itstrade or business, it makes payments ofrents, commissions, or other fixed ordeterminable income (see section 6041)totaling $600 or more to any one personduring the calendar year.

q Form 5471, Information Return of U.S.Persons With Respect to Certain ForeignCorporations. A partnership may have tofile Form 5471 if it (a) controls a foreigncorporation; or (b) acquires, disposes of,or owns 5% or more in value of theoutstanding stock of a foreign corporation;or (c) owns stock in a corporation that isa controlled foreign corporation for anuninterrupted period of 30 days or moreduring any tax year of the foreigncorporation, and it owned that stock on

the last day of that year.q Form 5713, International BoycottReport, is used by persons havingoperations in, or related to, a boycottingcountry, company, or national of acountry, to report those operations andfigure the loss of certain tax benefits. Thepartnership must give each partner a copyof the Form 5713 filed by the partnershipif there has been participation in, orcooperation with, an international boycott.q Form 8264, Application for Registrationof a Tax Shelter. Tax shelter organizersmust file Form 8264 to get a tax shelterregistration number from the IRS.

q Form 8271, Investor Reporting of TaxShelter Registration Number.Partnerships that have acquired aninterest in a tax shelter that is required tobe registered use Form 8271 to report thetax shelter's registration number. AttachForm 8271 to any return on which adeduction, credit, loss, or other tax benefitattributable to a tax shelter is taken or anyincome attributable to a tax shelter isreported.q Form 8275, Disclosure Statement. FileForm 8275 to disclose items or positions,except those contrary to a regulation, thatare not otherwise adequately disclosedon a tax return. The disclosure is madeto avoid the parts of the accuracy-relatedpenalty imposed for disregard of rules orsubstantial understatement of tax. Form8275 is also used for disclosures relatingto preparer penalties for understatementsdue to unrealistic positions or disregardof rules.q Form 8275-R, Regulation DisclosureStatement, is used to disclose any itemon a tax return for which a position hasbeen taken that is contrary to Treasuryregulations.

q Forms 8288 and 8288-A, U.S.Withholding Tax Return for Dispositionsby Foreign Persons of U.S. Real PropertyInterests; and Statement of Withholdingon Dispositions by Foreign Persons ofU.S. Real Property Interests. Use theseforms to report and send withheld tax onthe sale of U.S. real property by a foreignperson. See section 1445 and the relatedregulations for additional information.q Form 8300, Report of Cash PaymentsOver $10,000 Received in a Trade orBusiness. File this form to report thereceipt of more than $10,000 in cash orforeign currency in one transaction or aseries of related transactions.q Form 8594, Asset AcquisitionStatement. Both the purchaser and sellerof a group of assets constituting a tradeor business must file this form if section197 intangibles attach, or could attach, tosuch assets and if the purchaser's basisin the assets is determined only by theamount paid for the assets.q Form 8697, Interest ComputationUnder the Look-Back Method forCompleted Long-Term Contracts.

Partnerships that are not closely held usethis form to figure the interest due or tobe refunded under the look-back methodof section 460(b)(2) on certain long-termcontracts that are accounted for undereither the percentage ofcompletion-capitalized cost method or thepercentage of completion method. Closelyheld partnerships should see theinstructions on page 28 for line 25, item10, of Schedule K-1 for details on theForm 8697 information they must provideto their partners.q Forms 8804, 8805, and 8813, AnnualReturn for Partnership Withholding Tax(Section 1446); Foreign Partner'sInformation Statement of Section 1446Withholding Tax; and PartnershipWithholding Tax Payment (Section 1446).File Forms 8804 and 8805 if thepartnership had effectively connectedgross income and foreign partners for thetax year. Use Form 8813 to sendinstallment payments of withheld taxbased on effectively connected taxableincome allocable to foreign partners.

Exception: Publicly traded partnershipsthat do not elect to pay tax based oneffectively connected taxable income donot file these forms. They must insteadwithhold tax on distributions to foreign

partners and report and send paymentsusing Forms 1042 and 1042-S. Seesection 1446 for more information.q Form 8832, Entity ClassificationElection. Except for a business entityautomatically classified as a corporation,a business entity with at least twomembers may choose to be classifiedeither as a partnership or an associationtaxable as a corporation. A domesticeligible entity with at least two membersthat does not file Form 8832 is classifiedunder the default rules as a partnership.However, a foreign eligible entity with at



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least two members is classified under thedefault rules as a partnership only if atleast one member does not have limitedliability. File Form 8832 only if the entitydoes not want to be classified under thesedefault rules or if it wants to change itsclassification.q Form 8865, Return of U.S. Person WithRespect To Certain Foreign Partnerships.A domestic partnership that contributedproperty after August 5, 1997, to a foreignpartnership in exchange for a partnershipinterest may have to file Form 8865 if: (a)immediately after the contribution, thepartnership owned, directly or indirectly,at least a 10% interest in the foreignpartnership; or (b) the FMV of theproperty you contributed to the foreignpartnership in exchange for a partnershipinterest, when added to othercontributions of property made to thepartnership during the preceding12-month period, exceeds $100,000.Also, the domestic partnership may haveto file Form 8865 to report certaindispositions by a foreign partnership ofproperty it previously contributed to that

partnership if it was a partner at the timeof the disposition. For more details,including penalties that may apply, seeForm 8865 and its separate instructions.q Form 8866, Interest ComputationUnder the Look-Back Method for PropertyDepreciated Under the Income ForecastMethod. Partnerships that are not closelyheld use this form to figure the interestdue or to be refunded under the look-backmethod of section 167(g)(2) for certainproperty placed in service afterSeptember 13, 1995, depreciated underthe income forecast method. Closely heldpartnerships should see the instructionson page 28 for line 25, item 19, of

Schedule K-1 for details on the Form8866 information they must provide totheir partners.

AttachmentsAttach schedules in alphabetical orderand other forms in numerical order afterForm 1065.

To assist us in processing the return,complete every applicable entry space onForm 1065 and Schedule K-1. If youattach statements, do not write Seeattached instead of completing theentry spaces on the forms. Penaltiesmay be assessed if the partnership

files an incomplete return.If you need more space on the forms

or schedules, attach separate sheets. Usethe same size and format as on theprinted forms. But show your totals onthe printed forms. Be sure to put thepartnership's name and employeridentification number (EIN) on each sheet.

Separately Stated ItemsPartners must take into accountseparately (under section 702(a)) theirdistributive shares of the following items

(whether or not they are actuallydistributed):

1. Ordinary income or loss from tradeor business activities.

2. Net income or loss from rental realestate activities.

3. Net income or loss from other rentalactivities.

4. Gains and losses from sales orexchanges of capital assets.

5. Gains and losses from sales or

exchanges of property described insection 1231.

6. Charitable contributions.

7. Dividends (passed through tocorporate partners) that qualify for thedividends-received deduction.

8. Taxes described in section 901 paidor accrued to foreign countries and topossessions of the United States.

9. Other items of income, gain, loss,deduction, or credit, to the extent providedby regulations. Examples of such itemsinclude nonbusiness expenses, intangibledrilling and development costs, and soiland water conservation expenditures.

Elections Made by thePartnershipGenerally, the partnership decides how tofigure taxable income from its operations.For example, it chooses the accountingmethod and depreciation methods it willuse. The partnership also makeselections under the following sections:

1. Section 179 (election to expensecertain tangible property).

2. Section 614 (definition ofproperty mines, wells, and other naturaldeposits). This election must be made

before the partners figure their individualdepletion allowances under section613A(c)(7)(D).

3. Section 1033 (involuntaryconversions).

4. Section 754 (manner of electingoptional adjustment to basis ofpartnership property).

Under section 754, a partnership mayelect to adjust the basis of partnershipproperty when property is distributed orwhen a partnership interest is transferred.If the election is made with respect to atransfer of a partnership interest (section743(b)) and the assets of the partnershipconstitute a trade or business forpurposes of section 1060(c), then thevalue of any goodwill transferred must bedetermined in the manner provided inTemporary Regulations section1.1060-1T. Once an election is madeunder section 754, it applies both to alldistributions and to all transfers madeduring the tax year and in all subsequenttax years unless the election is revoked.See Regulations section 1.754-1(c).

This election must be made in astatement that is filed with thepartnership's timely filed return (including

any extension) for the tax year duringwhich the distribution or transfer occurs.The statement must include:q The name and address of thepartnership.q A declaration that the partnership electsunder section 754 to apply the provisionsof section 734(b) and section 743(b).q The signature of the general partnerauthorized to sign the partnership return.

The partnership can get an automatic

12-month extension to make the section754 election provided corrective action istaken within 12 months of the originaldeadline for making the election. Fordetails, see Regulations section301.9100-2.

See section 754 and the relatedregulations for more information.

If there is a distribution of propertyconsisting of an interest in anotherpartnership, see section 734(b).

Elections Made by EachPartnerElections under the following sections aremade by each partner separately on thepartner's tax return:

1. Section 59(e) (election to deductratably certain qualified expenditures suchas intangible drilling costs, miningexploration expenses, or research andexperimental expenditures).

2. Section 108 (income fromdischarge of indebtedness).

3. Section 617 (deduction andrecapture of certain mining explorationexpenditures paid or incurred).

4. Section 901 (foreign tax credit).

Partner's Dealings WithPartnershipIf a partner engages in a transaction withhis or her partnership, other than in hisor her capacity as a partner, the partneris treated as not being a member of thepartnership for that transaction. Specialrules apply to sales or exchanges ofproperty between partnerships andcertain persons, as explained in Pub. 541,Partnerships.

Contributions to thePartnership

Generally, no gain (loss) is recognized tothe partnership or any of the partnerswhen property is contributed to thepartnership in exchange for an interest inthe partnership. This rule does not applyto any gain realized on a transfer ofproperty to a partnership that would betreated as an investment company (withinthe meaning of section 351) if thepartnership were incorporated. If, as aresult of a transfer of property to apartnership, there is a direct or indirecttransfer of money or other property to the



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transferring partner, the partner may haveto recognize gain on the exchange.

The basis to the partnership of propertycontributed by a partner is the adjustedbasis in the hands of the partner at thetime it was contributed, plus any gainrecognized (under section 721(b)) by thepartner at that time. See section 723 formore information.

Dispositions of Contributed

PropertyIf the partnership disposes of propertycontributed to the partnership by apartner, income, gain, loss, anddeductions from that property must beallocated among the partners to take intoaccount the difference between theproperty's basis and its FMV at the timeof the contribution.

For property contributed to thepartnership, the contributing partner mustrecognize gain or loss on a distribution ofthe property to another partner within 5years of being contributed. For propertycontributed after June 8, 1997, the 5-year

period is generally extended to 7 years.The gain or loss is equal to the amountthat the contributing partner should haverecognized if the property had been soldfor its FMV when distributed, because ofthe difference between the property'sbasis and its FMV at the time ofcontribution.

See section 704(c) for details and otherrules on dispositions of contributedproperty. See section 724 for thecharacter of any gain or loss recognizedon the disposition of unrealizedreceivables, inventory items, or capitalloss property contributed to thepartnership by a partner.

Recognition ofPrecontribution Gain onCertain PartnershipDistributionsA partner who contributes appreciatedproperty to the partnership must includein income any precontribution gain to theextent the FMV of other property (otherthan money) distributed to the partner bythe partnership exceeds the adjustedbasis of his or her partnership interest justbefore the distribution. Precontributiongain is the net gain, if any, that would

have been recognized under section704(c)(1)(B) if the partnership haddistributed to another partner all theproperty that had been contributed to thepartnership by the distributee partnerwithin 5 years of the distribution and thatwas held by the partnership just beforethe distribution. For property contributedafter June 8, 1997, the 5-year period isgenerally extended to 7 years.

Appropriate basis adjustments are tobe made to the adjusted basis of thedistributee partner's interest in the

partnership and the partnership's basis inthe contributed property to reflect the gainrecognized by the partner.

For more details and exceptions, seePub. 541.

Unrealized Receivables andInventory ItemsGenerally, if a partner sells or exchangesa partnership interest where unrealizedreceivables or inventory items areinvolved, the transferor partner mustnotify the partnership, in writing, within 30days of the exchange. The partnershipmust then file Form 8308, Report of aSale or Exchange of Certain PartnershipInterests.

If a partnership distributes unrealizedreceivables or substantially appreciatedinventory items in exchange for all or partof a partner's interest in other partnershipproperty (including money), treat thetransaction as a sale or exchangebetween the partner and the partnership.Treat the partnership gain (loss) asordinary income (loss). The income (loss)

is specially allocated only to partnersother than the distributee partner.

If a partnership gives other property(including money) for all or part of thatpartner's interest in the partnership'sunrealized receivables or substantiallyappreciated inventory items, treat thetransaction as a sale or exchange of theproperty.

See Rev. Rul. 84-102, 1984-2 C.B. 119,for information on the tax consequencesthat result when a new partner joins apartnership that has liabilities andunrealized receivables. Also, see Pub.541 for more information on unrealizedreceivables and inventory items.

Passive Activity LimitationsIn general, section 469 limits the amountof losses, deductions, and credits thatpartners may claim from passiveactivities. The passive activity limitationsdo not apply to the partnership. Instead,they apply to each partner's share of anyincome or loss and credit attributable toa passive activity. Because the treatmentof each partner's share of partnershipincome or loss and credit depends on thenature of the activity that generated it, thepartnership must report income or lossand credits separately for each activity.

The instructions below (pages 812)and the instructions for Schedules K andK-1 (pages 1828) explain the applicablepassive activity limitation rules andspecify the type of information thepartnership must provide to its partnersfor each activity. If the partnership hasmore than one activity, it must reportinformation for each activity on anattachment to Schedules K and K-1.

Generally, passive activities include (a)activities that involve the conduct of atrade or business if the partner does not

materially participate in the activity; and(b) all rental activities (defined on page9), regardless of the partner'sparticipation. For exceptions, seeActivities That Are Not PassiveActivities below. The level of eachpartner's participation in an activity mustbe determined by the partner.

The passive activity rules provide thatlosses and credits from passive activitiescan generally be applied only againstincome and tax from passive activities.Thus, passive losses and credits cannotbe applied against income from salaries,wages, professional fees, or a businessin which the taxpayer materiallyparticipates; against portfolio income(defined on page 10); or against the taxrelated to any of these types of income.

Special provisions apply to certainactivities. First, the passive activitylimitations must be applied separatelywith respect to a net loss from passiveactivities held through a publicly tradedpartnership. Second, special rules requirethat net income from certain activities thatwould otherwise be treated as passive

income must be recharacterized asnonpassive income for purposes of thepassive activity limitations.

To allow each partner to correctly applythe passive activity limitations, thepartnership must report income or lossand credits separately for each of thefollowing types of activities and income:trade or business activities, rental realestate activities, rental activities otherthan rental real estate, and portfolioincome.

Activities That Are Not PassiveActivities

Passive activities do not include:

1. Trade or business activities inwhich the partner materially participatedfor the tax year.

2. Any rental real estate activity inwhich the partner materially participatedand met both of the following conditionsfor the tax year:

a. More than half of the personalservices the partner performed in tradesor businesses were performed in realproperty trades or businesses in which heor she materially participated, and

b. The partner performed more than750 hours of services in real propertytrades or businesses in which he or shematerially participated.

Note: For a partner that is a closely heldC corporation (defined in section465(a)(1)(B)), the above conditions aretreated as met if more than 50% of thecorporation's gross receipts are from realproperty trades or businesses in which thecorporation materially participated.

For purposes of this rule, each interestin rental real estate is a separate activity,unless the partner elects to treat allinterests in rental real estate as oneactivity.



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If the partner is married filing jointly,either the partner or his or her spousemust separately meet both of the aboveconditions, without taking into accountservices performed by the other spouse.

A real property trade or business is anyreal property development,redevelopment, construction,reconstruction, acquisition, conversion,rental, operation, management, leasing,or brokerage trade or business. Servicesthe partner performed as an employee arenot treated as performed in a real propertytrade or business unless he or she ownedmore than 5% of the stock (or more than5% of the capital or profits interest) in theemployer.

3. An interest in an oil or gas welldrilled or operated under a workinginterest if at any time during the tax yearthe partner held the working interestdirectly or through an entity that did notlimit the partner's liability (e.g., an interestas a general partner). This exceptionapplies regardless of whether the partnermaterially participated for the tax year.

4. The rental of a dwelling unit used

by a partner for personal purposes duringthe year for more than the greater of 14days or 10% of the number of days thatthe residence was rented at fair rentalvalue.

5. An activity of trading personalproperty for the account of owners ofinterests in the activity. For purposes ofthis rule, personal property meansproperty that is actively traded, such asstocks, bonds, and other securities. SeeTemporary Regulations section1.469-1T(e)(6).

Trade or Business Activities

A trade or business activity is an activity(other than a rental activity or an activitytreated as incidental to an activity ofholding property for investment) that:

1. Involves the conduct of a trade orbusiness (within the meaning of section162),

2. Is conducted in anticipation ofstarting a trade or business, or

3. Involves research or experimentalexpenditures deductible under section174 (or that would be if you chose todeduct rather than capitalize them).

If the partner does not materiallyparticipate in the activity, a trade orbusiness activity held through apartnership is generally a passive activityof the partner.

Each partner must determine if he orshe materially participated in an activity.As a result, while the partnership's overalltrade or business income (loss) isreported on page 1 of Form 1065, thespecific income and deductions from eachseparate trade or business activity mustbe reported on attachments to Form 1065.Similarly, while each partner's allocableshare of the partnership's overall trade or

business income (loss) is reported on line1 of Schedule K-1, each partner'sallocable share of the income anddeductions from each trade or businessactivity must be reported on attachmentsto each Schedule K-1. See PassiveActivity Reporting Requirements onpage 11 for more information.

Rental Activities

Generally, except as noted below, if thegross income from an activity consists of

amounts paid principally for the use ofreal or personal tangible property held bythe partnership, the activity is a rentalactivity.

There are several exceptions to thisgeneral rule. Under these exceptions, anactivity involving the use of real orpersonal tangible property is not a rentalactivity if any of the following apply:q The average period of customer use(defined below) for such property is 7days or less.q The average period of customer use forsuch property is 30 days or less andsignificant personal services (defined

below) are provided by or on behalf of thepartnership.q Extraordinary personal services(defined below) are provided by or onbehalf of the partnership.q The rental of such property is treatedas incidental to a nonrental activity of thepartnership under Temporary Regulationssection 1.469-1T(e)(3)(vi) andRegulations section 1.469-1(e)(3)(vi).q The partnership customarily makes theproperty available during definedbusiness hours for nonexclusive use byvarious customers.q The partnership provides property for

use in a nonrental activity of a partnershipor joint venture in its capacity as an ownerof an interest in such partnership or jointventure. Whether the partnership providesproperty used in an activity of anotherpartnership or of a joint venture in thepartnership's capacity as an owner of aninterest in the partnership or joint ventureis determined on the basis of all the factsand circumstances.

In addition, a guaranteed paymentdescribed in section 707(c) is not incomefrom a rental activity under anycircumstances.Average period of customer use.

Figure the average period of customeruse for a class of property by dividing thetotal number of days in all rental periodsby the number of rentals during the taxyear. If the activity involves renting morethan one class of property, multiply theaverage period of customer use of eachclass by the ratio of the gross rentalincome from that class to the activity'stotal gross rental income. The activity'saverage period of customer use equalsthe sum of these class-by-class averageperiods weighted by gross income. SeeRegulations section 1.469-1(e)(3)(iii).

Significant personal services. Personalservices include only services performedby individuals. In determining whetherpersonal services are significant personalservices, consider all the relevant factsand circumstances. Relevant facts andcircumstances include how often theservices are provided, the type andamount of labor required to perform theservices, and the value of the services inrelation to the amount charged for use ofthe property.

The following services are notconsidered in determining whetherpersonal services are significant:q Services necessary to permit the lawfuluse of the rental property.q Services performed in connection withimprovements or repairs to the rentalproperty that extend the useful life of theproperty substantially beyond the averagerental period.q Services provided in connection withthe use of any improved real property thatare similar to those commonly provided inconnection with long-term rentals ofhigh-grade commercial or residential

property. Examples include cleaning andmaintenance of common areas, routinerepairs, trash collection, elevator service,and security at entrances.Extraordinary personal services.Services provided in connection withmaking rental property available forcustomer use are extraordinary personalservices only if the services are performedby individuals and the customers' use ofthe rental property is incidental to theirreceipt of the services.

For example, a patient's use of ahospital room generally is incidental to thecare received from the hospital's medical

staff. Similarly, a student's use of adormitory room in a boarding school isincidental to the personal servicesprovided by the school's teaching staff.Rental activity incidental to a nonrentalactivity. An activity is not a rental activityif the rental of the property is incidental toa nonrental activity, such as the activityof holding property for investment, a tradeor business activity, or the activity ofdealing in property.

Rental of property is incidental to anactivity of holding property for investmentif both of the following apply:q The main purpose for holding theproperty is to realize a gain from theappreciation of the property.q The gross rental income from suchproperty for the tax year is less than 2%of the smaller of the property's unadjustedbasis or its FMV.

Rental of property is incidental to atrade or business activity if all of thefollowing apply:q The partnership owns an interest in thetrade or business at all times during theyear.



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q The rental property was mainly used inthe trade or business activity during thetax year or during at least 2 of the 5preceding tax years.q The gross rental income from theproperty for the tax year is less than 2%of the smaller of the property's unadjustedbasis or its FMV.

The sale or exchange of property thatis both rented and sold or exchangedduring the tax year (where the gain or lossis recognized) is treated as incidental tothe activity of dealing in property if, at thetime of the sale or exchange, the propertywas held primarily for sale to customersin the ordinary course of the partnership'strade or business.

See Temporary Regulations section1.469-1T(e)(3) and Regulations section1.469-1(e)(3) for more information on thedefinition of rental activities for purposesof the passive activity limitations.Reporting of rental activities. Inreporting the partnership's income orlosses and credits from rental activities,the partnership must separately reportrental real estate activities and rental

activities other than rental real estateactivities.

Partners who actively participate in arental real estate activity may be able todeduct part or all of their rental real estatelosses (and the deduction equivalent ofrental real estate credits) against income(or tax) from nonpassive activities. Thecombined amount of rental real estatelosses and the deduction equivalent ofrental real estate credits from all sources(including rental real estate activities notheld through the partnership) that may beclaimed is limited to $25,000. This$25,000 amount is generally reduced for

high-income partners.Report rental real estate activity income(loss) on Form 8825, Rental Real EstateIncome and Expenses of a Partnershipor an S Corporation, and line 2 ofSchedules K and K-1 rather than on page1 of Form 1065. Report credits related torental real estate activities on lines 12band 12c and low-income housing creditson line 12a of Schedules K and K-1.

Report income (loss) from rentalactivities other than rental real estate online 3 and credits related to rentalactivities other than rental real estate online 12d of Schedules K and K-1.

Portfolio IncomeGenerally, portfolio income includes allgross income, other than income derivedin the ordinary course of a trade orbusiness, that is attributable to interest;dividends; royalties; income from a realestate investment trust, a regulatedinvestment company, a real estatemortgage investment conduit, a commontrust fund, a controlled foreigncorporation, a qualified electing fund, ora cooperative; income from thedisposition of property that produces

income of a type defined as portfolioincome; and income from the dispositionof property held for investment.

Solely for purposes of the precedingparagraph, gross income derived in theordinary course of a trade or businessincludes (and portfolio income, therefore,does not include) only the following typesof income:q Interest income on loans andinvestments made in the ordinary courseof a trade or business of lending money.q Interest on accounts receivable arisingfrom the performance of services or thesale of property in the ordinary course ofa trade or business of performing suchservices or selling such property, but onlyif credit is customarily offered tocustomers of the business.q Income from investments made in theordinary course of a trade or business offurnishing insurance or annuity contractsor reinsuring risks underwritten byinsurance companies.q Income or gain derived in the ordinarycourse of an activity of trading or dealingin any property if such activity constitutesa trade or business (unless the dealerheld the property for investment at anytime before such income or gain isrecognized).q Royalties derived by the taxpayer in theordinary course of a trade or business oflicensing intangible property.q Amounts included in the gross incomeof a patron of a cooperative by reason ofany payment or allocation to the patronbased on patronage occurring withrespect to a trade or business of thepatron.q Other income identified by the IRS asincome derived by the taxpayer in the

ordinary course of a trade or business.See Temporary Regulations section

1.469-2T(c)(3) for more information onportfolio income.

Report portfolio income on line 4 ofSchedules K and K-1, rather than on page1 of Form 1065. Report deductionsrelated to portfolio income on line 10 ofSchedules K and K-1.

Grouping Activities

Generally, one or more trade or businessactivities or rental activities may betreated as a single activity if the activitiesmake up an appropriate economic unit for

the measurement of gain or loss underthe passive activity rules. Whetheractivities make up an appropriateeconomic unit depends on all the relevantfacts and circumstances. The factorsgiven the greatest weight in determiningwhether activities make up an appropriateeconomic unit are:q Similarities and differences in types oftrades or businesses.q The extent of common control.q The extent of common ownership.q Geographical location.

q Reliance between or among theactivities.

Example. The partnership has asignificant ownership interest in a bakeryand a movie theater in Baltimore and abakery and a movie theater inPhiladelphia. Depending on the relevantfacts and circumstances, there may bemore than one reasonable method forgrouping the partnership's activities. Forinstance, the following groupings may ormay not be permissible:q A single activity,q A movie theater activity and a bakeryactivity,q A Baltimore activity and a Philadelphiaactivity, orq Four separate activities.

Once the partnership chooses agrouping under these rules, it mustcontinue using that grouping in later taxyears unless a material change in thefacts and circumstances makes it clearlyinappropriate.

The IRS may regroup the partnership'sactivities if the partnership's grouping fails

to reflect one or more appropriateeconomic units and one of the primarypurposes of the grouping is to avoid thepassive activity limitations.

Limitation on grouping certainactivities. The following activities maynot be grouped together:

1. A rental activity with a trade orbusiness activity unless the activitiesbeing grouped together make up anappropriate economic unit, and

a. The rental activity is insubstantialrelative to the trade or business activityor vice versa, or

b. Each owner of the trade or

business activity has the sameproportionate ownership interest in therental activity. If so, the portion of therental activity involving the rental ofproperty to be used in the trade orbusiness activity may be grouped with thetrade or business activity.

2. An activity involving the rental ofreal property with an activity involving therental of personal property (except forpersonal property provided in connectionwith the real property or vice versa).

3. Any activity with another activity ina different type of business and in whichthe partnership holds an interest as alimited partner or as a limited

entrepreneur (as defined in section464(e)(2)) if that other activity engages inholding, producing, or distributing motionpicture films or videotapes; farming;leasing section 1245 property; orexploring for (or exploiting) oil and gasresources or geothermal deposits.

Activities conducted through otherpartnerships. Once a partnershipdetermines its activities under these rules,the partnership as a partner may usethese rules to group those activities with:q Each other,



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q Activities conducted directly by thepartnership, orq Activities conducted through otherpartnerships.

A partner may not treat as separateactivities those activities grouped togetherby a partnership.

Recharacterization of PassiveIncome

Under Temporary Regulations section

1.469-2T(f) and Regulations section1.469-2(f), net passive income fromcertain passive activities must be treatedas nonpassive income. Net passiveincome is the excess of an activity'spassive activity gross income over itspassive activity deductions (current yeardeductions and prior year unallowedlosses).

Income from the following six sourcesis subject to recharacterization. Note thatany net passive income recharacterizedas nonpassive income is treated asinvestment income for purposes offiguring investment interest expenselimitations if it is from (a) an activity of

renting substantially nondepreciableproperty from an equity-financed lendingactivity or (b) an activity related to aninterest in a pass-through entity thatlicenses intangible property.

1.Significant participation passiveactivities. A significant participationpassive activity is any trade or businessactivity in which the partner bothparticipates for more than 100 hoursduring the tax year and does notmaterially participate. Because eachpartner must determine the partner's levelof participation, the partnership will not beable to identify significant participation

passive activities.2.Certain nondepreciable rentalproperty activities. Net passive incomefrom a rental activity is nonpassiveincome if less than 30% of the unadjustedbasis of the property used or held for useby customers in the activity is subject todepreciation under section 167.

3.Passive equity-financed lendingactivities. If the partnership has netincome from a passive equity-financedlending activity, the smaller of the netpassive income or the equity-financedinterest income from the activity isnonpassive income.

Note: The amount of income from theactivities in paragraphs1 through3thatany partner will be required torecharacterize as nonpassive income maybe limited under Temporary Regulationssection 1.469-2T(f)(8). Because thepartnership will not have informationregarding all of a partner's activities, itmust identify all partnership activitiesmeeting the definitions in paragraphs2and3as activities that may be subject torecharacterization.

4.Rental of property incidental toa development activity. Net rental

activity income is the excess of passiveactivity gross income from renting ordisposing of property over passive activitydeductions (current year deductions andprior year unallowed losses) that arereasonably allocable to the rentedproperty. Net rental activity income isnonpassive income for a partner if all ofthe following apply:

q The partnership recognizes gain fromthe sale, exchange, or other dispositionof the rental property during the tax year.q The use of the item of property in therental activity started less than 12 monthsbefore the date of disposition. The use ofan item of rental property begins on thefirst day that (a) the partnership owns aninterest in the property; (b) substantiallyall of the property is either rented or heldout for rent and ready to be rented; and(c) no significant value-enhancingservices remain to be performed.q The partner materially or significantlyparticipated for any tax year in an activitythat involved performing services toenhance the value of the property (or anyother item of property, if the basis of the

property disposed of is determined inwhole or in part by reference to the basisof that item of property).

Because the partnership cannotdetermine a partner's level ofparticipation, the partnership must identifynet income from property describedabove (without regard to the partner'slevel of participation) as income that maybe subject to recharacterization.

5.Rental of property to anonpassive activity. If a taxpayer rentsproperty to a trade or business activity inwhich the taxpayer materially participates,the taxpayer's net rental activity income

from the property is nonpassive income.6.Acquisition of an interest in a

pass-through entity that licensesintangible property. Generally, netroyalty income from intangible property isnonpassive income if the taxpayeracquired an interest in the pass-throughentity after the pass-through entitycreated the intangible property orperformed substantial services, orincurred substantial costs in developingor marketing the intangible property. Netroyalty income means the excess ofpassive activity gross income fromlicensing or transferring any right inintangible property over passive activity

deductions (current year deductions andprior year unallowed losses) that arereasonably allocable to the intangibleproperty.

See Temporary Regulations section1.469-2T(f)(7)(iii) for exceptions to thisrule.

Passive Activity ReportingRequirements

To allow partners to correctly apply thepassive activity loss and credit rules, any

partnership that carries on more than oneactivity must:

1. Provide an attachment for eachactivity conducted through the partnershipthat identifies the type of activityconducted (trade or business, rental realestate, rental activity other than rental realestate, or investment).

2. On the attachment for each activity,provide a schedule, using the same linenumbers as shown on Schedule K-1,detailing the net income (loss), credits,and all items required to be separatelystated under section 702(a) from eachtrade or business activity, from eachrental real estate activity, from each rentalactivity other than a rental real estateactivity, and from investments.

3. Identify the net income (loss) andcredits from each oil or gas well drilled oroperated under a working interest that anypartner (other than a partner whose onlyinterest in the partnership during the yearis as a limited partner) holds through thepartnership. Further, if any partner had aninterest as a general partner in thepartnership during less than the entire

year, the partnership must identify boththe disqualified deductions from each wellthat the partner must treat as passiveactivity deductions, and the ratableportion of the gross income from eachwell that the partner must treat as passiveactivity gross income.

4. Identify the net income (loss) andthe partner's share of partnership interestexpense from each activity of renting adwelling unit that any partner uses forpersonal purposes during the year formore than the greater of 14 days or 10%of the number of days that the residenceis rented at fair rental value.

5. Identify the net income (loss) andthe partner's share of partnership interestexpense from each activity of tradingpersonal property conducted through thepartnership.

6. For any gain (loss) from thedisposition of an interest in an activity orof an interest in property used in anactivity (including dispositions before1987 from which gain is being recognizedafter 1986):

a. Identify the activity in which theproperty was used at the time ofdisposition.

b. If the property was used in morethan one activity during the 12 monthspreceding the disposition, identify theactivities in which the property was usedand the adjusted basis allocated to eachactivity.

c. For gains only, if the property wassubstantially appreciated at the time of thedisposition and the applicable holdingperiod specified in Regulations section1.469-2(c)(2)(iii)(A) was not satisfied,identify the amount of the nonpassive gainand indicate whether the gain isinvestment income under the provisions



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of Regulations section1.469-2(c)(2)(iii)(F).

7. Specify the amount of grossportfolio income, the interest expenseproperly allocable to portfolio income, andexpenses other than interest expense thatare clearly and directly allocable toportfolio income.

8. Identify separately any of thefollowing types of payments to partners:

a. Payments to a partner for services

other than in the partner's capacity as apartner under section 707(a).

b. Guaranteed payments to a partnerfor services under section 707(c).

c. Guaranteed payments for use ofcapital.

d. If section 736(a)(2) payments aremade for unrealized receivables or forgoodwill, the amount of the payments andthe activities to which the payments areattributable.

e. If section 736(b) payments aremade, the amount of the payments andthe activities to which the payments areattributable.

9. Identify the ratable portion of anysection 481 adjustment (whether a netpositive or a net negative adjustment)allocable to each partnership activity.

10. Identify the amount of gross incomefrom each oil or gas property of thepartnership.

11. Identify any gross income fromsources that are specifically excludedfrom passive activity gross income,including:

a. Income from intangible property ifthe partner is an individual and thepartner's personal efforts significantlycontributed to the creation of the property.

b. Income from state, local, or foreignincome tax refunds.

c. Income from a covenant not tocompete (in the case of a partner who isan individual and who contributed thecovenant to the partnership).

12. Identify any deductions that are notpassive activity deductions.

13. If the partnership makes a full orpartial disposition of its interest in anotherentity, identify the gain (loss) allocable toeach activity conducted through the entity,and the gain allocable to a passive activitythat would have been recharacterized asnonpassive gain had the partnership

disposed of its interest in property used inthe activity (because the property wassubstantially appreciated at the time of thedisposition, and the gain representedmore than 10% of the partner's total gainfrom the disposition).

14. Identify the following items fromactivities that may be subject to therecharacterization rules under TemporaryRegulations section 1.469-2T(f) andRegulations section 1.469-2(f):

a. Net income from an activity ofrenting substantially nondepreciableproperty.

b. The smaller of equity-financedinterest income or net passive incomefrom an equity-financed lending activity.

c. Net rental activity income fromproperty that was developed (by thepartner or the partnership), rented, andsold within 12 months after the rental ofthe property commenced.

d. Net rental activity income from therental of property by the partnership to atrade or business activity in which thepartner had an interest (either directly orindirectly).

e. Net royalty income from intangibleproperty if the partner acquired thepartner's interest in the partnership afterthe partnership created the intangibleproperty or performed substantialservices, or incurred substantial costs indeveloping or marketing the intangibleproperty.

15. Identify separately the credits fromeach activity conducted by or through thepartnership.

Specific InstructionsThese instructions follow the line numberson the first page of Form 1065. Theaccompanying schedules will bediscussed separately. Specificinstructions for most of the lines areprovided. Lines that are not discussed areself-explanatory.

Fill in all applicable lines andschedules.

Enter any items specially allocated tothe partners on the appropriate line of theapplicable partner's Schedule K-1. Enterthe total amount on the appropriate lineof Schedule K. Do not enter separately

stated amounts on the numbered lines onForm 1065, page 1, or on Schedule A orD.

File all four pages of Form 1065.However, if the answer to Question 5 ofSchedule B is Yes, page 4 is optional.Also attach a Schedule K-1 to Form 1065for each partner.

File only one Form 1065 for eachpartnership. Mark duplicate copy on anycopy you give to a partner.

If a syndicate, pool, joint venture, orsimilar group files Form 1065, it mustattach a copy of the agreement and allamendments to the return, unless a copyhas previously been filed.

General Information

Name, Address, and EmployerIdentification Number

Use the label that was mailed to thepartnership. Cross out any errors andprint the correct information on the label.Name. If the partnership did not receivea label, print or type the legal name of thepartnership as it appears in thepartnership agreement.

Address. Include the suite, room, orother unit number after the street address.If a preaddressed label is used, includethis information on the label.

If the Post Office does not deliver mailto the street address and the partnershiphas a P.O. box, show the box numberinstead.

If the partnership's address is outsidethe United States or its possessions orterritories, enter the information on theline for City or town, state, and ZIPcode in the following order: city, provinceor state, and the foreign country. Followthe foreign country's practice in placingthe postal code in the address. Do notabbreviate the country name.

If the partnership has had a change ofaddress, check box G(3).

If the partnership changes its mailingaddress after filing its return, it can notifythe IRS by filing Form 8822, Change ofAddress.Employer identification number (EIN).Show the correct EIN in item D on page1 of Form 1065. If the partnership doesnot have an EIN, it must apply for one onForm SS-4, Application for EmployerIdentification Number. Form SS-4 hasinformation on how to apply for an EIN bymail or by telephone. If the partnershiphas not received its EIN by the time thereturn is due, write Applied for in thespace for the EIN. See Pub. 583, Startinga Business and Keeping Records, formore information.

Do not request a new EIN for apartnership that terminated because of asale or exchange of at least 50% of thetotal interests in partnership capital andprofits.

Items A and C

Enter the applicable activity name and thecode number from the list beginning onpage 30.

For example, if, as its principalbusiness activity, the partnership (a)purchases raw materials, (b) subcontractsout for labor to make a finished productfrom the raw materials, and (c) retains titleto the goods, the partnership isconsidered to be a manufacturer andmust enter Manufacturer in item A andenter in item C one of the codes (311110through 339900) listed underManufacturing on page 30.

Item FTotal AssetsYou are not required to complete item Fif the answer to Question 5 of ScheduleB is Yes.

If you are required to complete thisitem, enter the partnership's total assetsat the end of the tax year, as determinedby the accounting method regularly usedin keeping the partnership's books andrecords. If there were no assets at the endof the tax year, enter the total assets asof the beginning of the tax year.



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Item G

Do not check Final return (box G(2)) fora partnership that terminated because ofa sale or exchange of at least 50% of thetotal interests in partnership capital andprofits. However, be sure to file a returnfor the short year ending on the date oftermination.

IncomeCaution: Report only trade or businessactivity income on lines 1a through 8. Donot report rental activity income orportfolio income on these lines. Seethe instructions onPassive ActivityLimitationsbeginning on page 8 fordefinitions of rental income and portfolioincome. Rental activity income andportfolio income are reported onSchedules K and K-1. Rental real estateactivities are also reported on Form 8825.

Do not include any tax-exempt incomeon lines 1a through 8. A partnership thatreceives any tax-exempt income otherthan interest, or holds any property orengages in any activity that produces

tax-exempt income reports the amount ofthis income on line 20 of Schedules K andK-1.

Report tax-exempt interest income,including exempt-interest dividendsreceived as a shareholder in a mutualfund or other regulated investmentcompany, on line 19 of Schedules K andK-1.

See Deductions on page 14 forinformation on how to report expensesrelated to tax-exempt income.

If the partnership has had debtdischarged resulting from a title 11bankruptcy proceeding or while insolvent,

see Form 982, Reduction of TaxAttributes Due to Discharge ofIndebtedness, and Pub. 908, BankruptcyTax Guide.

Line 1aGross Receipts or Sales

Enter the gross receipts or sales from alltrade or business operations except thosethat must be reported on lines 4 through7. For example, do not include grossreceipts from farming on this line. Instead,show the net profit (loss) from farming online 5. Also, do not include on line 1arental activity income or portfolio income.See section 460 for special rules thatapply to long-term contracts.

Installment sales. Generally, theinstallment method cannot be used fordealer dispositions of property. A dealerdisposition is any disposition of personalproperty by a person who regularly sellsor otherwise disposes of personalproperty of the same type on theinstallment plan or any disposition of realproperty held for sale to customers in theordinary course of the taxpayer's trade orbusiness. The disposition of propertyused or produced

Documents

US Internal Revenue Service: i1065--1999