Can I deduct losses on a K-1?

This is a rhetorical question that many CPAs find themselves asking when preparing individual tax returns. Can a client take the losses reported on a K-1? This is not a simple yes or no answer when you are dealing with S corporation investments.

Most S corporation K-1s do not have basis information on them. The duty of keeping track of basis is left to the client or their CPA in most cases. It is much easier for a CPA to keep track of the basis if the investment in an S corporation is new. This becomes a difficult task if a CPA inherits a client who has invested in an S corporation for years but has no record of his or her basis.

Why is it important for clients and CPAs to keep track of basis in S corporation investments?

  • Corporate losses could be limited due to lack of basis
  • To determine gain or loss on disposition of stock or repayment of debt
  • To determine the amount of tax-free distributions that can be received from an S corporation

There is an increasing revenue gap and the IRS has increased its audits in recent years. CPAs have to ensure that their clients’ records are in good order. Deduct losses only when a client has basis. Gains and/or losses should be properly documented when a client sells the S corporation stock or when an S corporation repays shareholder loan.

The common practice at Anders is to set up a basis schedule for any S corporation investments that our clients are engaged in. Having proper documentation is key to ensuring that our clients’ returns are on solid grounds when they are selected for an audit.