Six K-1s, a partnership exit, and Section 1231
An investor with six passive K-1s sells one of them outright, and also sells business land and a machine out of his Schedule C shop. Two rules drive the whole return: Section 1231 netting with the five-year lookback, and what a complete disposition does to suspended passive losses.
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Taxpayer facts
Who this is and what their year looked like.
Grant and Renata Whitfield file jointly and live in Casper, Wyoming. Grant runs Whitfield Precision Machining as a sole proprietor and materially participates in it. Renata is not employed outside the home.
Grant also holds interests in six partnerships. He is a limited partner or non-managing member in every one of them, he does not materially participate in any of them, and neither spouse is a real estate professional. So all six are passive activities.
Three things happened in 2025. The machining shop sold an old lathe and a parcel of land it had held for nine years. Grant sold his entire interest in Sagebrush Storage LLC to an unrelated buyer. And he carries suspended passive losses into the year from three of the partnerships.
Source documents
The 11 documents you will prepare the return from: Business records, Whitfield Precision Machining, Asset dispositions, Whitfield Precision Machining, Closing statement, sale of Sagebrush Storage LLC interest, Suspended passive losses carried into 2025 (from the 2024 Form 8582), K-1 (Partner Share of Income (Form 1065), FINAL K-1), K-1 (Partner Share of Income (Form 1065)), K-1 (Partner Share of Income (Form 1065)), K-1 (Partner Share of Income (Form 1065)), K-1 (Partner Share of Income (Form 1065)), K-1 (Partner Share of Income (Form 1065)), 1099-INT (Interest Income).
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Objectives
What a correct return should capture.
- Start with Form 4797 Part III. The lathe is Section 1245 property: figure its gain (sale price less adjusted basis) and compare it to the depreciation taken to see how much is ordinary recapture and whether any of it reaches Section 1231.
- The land is Section 1231 property but not depreciable, so there is no recapture. Figure its gain and report it on Form 4797 Part I.
- Apply the Section 1231(c) five-year lookback. Grant has nonrecaptured net Section 1231 losses from an earlier year in the lookback period, so this year's net Section 1231 gain is converted to ORDINARY income up to that amount. Only what remains is long-term capital gain.
- Total the Form 4797 Part II ordinary income (the recapture plus the lookback amount) and report it on Schedule 1 line 4. Confirm for yourself that none of it is subject to self-employment tax.
- Identify the complete disposition. Grant sold his entire Sagebrush interest to an unrelated party in a fully taxable sale, so Section 469(g) releases that activity's losses in full: the current-year loss plus the suspended loss, all deductible this year.
- Figure the gain on the Sagebrush sale (the sale price less the adjusted outside basis) and treat it as passive income on Form 8582, even though it is reported as a capital gain on Schedule D. That gain is what lets the other activities' losses through.
- Run Form 8582 for the activities Grant still owns. Total the passive income from the K-1s and the disposition gain, let the Sagebrush losses use it first, and see how much is left to release the Cottonwood and Rawlins losses.
- Compare the combined current and suspended Cottonwood and Rawlins losses to the passive income that remains. Allow what it covers, suspend the rest to 2026, and allocate the suspension between the two activities pro rata.
- Check why the $25,000 rental real estate allowance does not help: Grant is a limited partner, so he cannot actively participate. Also check his modified AGI against the $150,000 point where the allowance is fully phased out.
- Compute QBI. The machining business qualifies, and the ordinary Section 1245 and Section 1231 lookback income is business income that belongs in QBI. The Section 1231 capital gain does not. Then watch the taxable income limit, which subtracts net capital gain and can cut the deduction well below 20% of QBI.
- Use the qualified dividends and capital gain worksheet, not the plain brackets. Compare ordinary taxable income to the 2025 MFJ 0% ceiling ($96,700) to see how much of the long-term gain is taxed at 0% and how much at 15%.
- Note that Wyoming has no state income tax, and check AGI against the $250,000 MFJ threshold for the Net Investment Income Tax.
Check your work
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