Partnership Tax Reporting: Active & Passive income on your K-1

In a limited partnership (LP) or other pass-through entities like LLCs, the K-1 forms are generally designed to report income and losses at the partner level based on the nature of the income—whether it's active or passive—so that it can be correctly reported on the partner’s individual tax returns (Form 1040). However, issuing separate K-1s to distinguish between passive and active income isn't the typical approach. Instead, the partnership or LLC can allocate and report the different types of income (active vs. passive) within a single K-1.

Here’s how it generally works (based on the 2023 K-1):

1. K-1 Reporting Structure:

   • Box 1 (Ordinary business income): This is where the partnership would report active business income. This includes any income from trade or business activities where material participation occurs.
   • Box 2 (Rental real estate income): Passive rental income, like long-term rental properties, would be reported here.
   • Box 3 (Other rental income): This can be used for short-term rental income that might qualify for the loophole or meet specific exceptions.
   • Box 4 (Guaranteed payments): If there are guaranteed payments to partners for services, this is also reported here as active income.
   • Box 20 (Other information): Specific tax preferences or elections (such as short-term rental exceptions) can be detailed here.

2. Active vs. Passive Income:

   • The active business income (for activities in which the partner materially participates) will be reported as non-passive income on the K-1.
   • The passive rental income from long-term rental properties will be reported as passive income.
   • For short-term rental income, if the activity meets the IRS material participation rules, it may be treated as active income. However, if the short-term rental loophole applies (e.g., the property is rented for fewer than 7 days on average and the taxpayer materially participates), it may be considered non-passive even though it is rental income.
3. Tax Reporting on the 1040:
   • • Active income (from businesses or short-term rentals with material participation) would typically be reported on Schedule E, with net earnings possibly subject to self-employment tax if applicable.
     • Passive income (from long-term rentals) would also be reported on Schedule E, but as passive income, subject to the passive activity loss (PAL) rules.
     • The correct categorization of income on the K-1 is crucial because it impacts how the income is treated for things like self-employment taxes and passive activity loss limitations.

It's a nuanced calculation, and a tax advisor familiar with your specific structure should be consulted to provide the best guidance based on your unique circumstances.