No Basis Adjustment Allowed in NJ Until LLP Interest is Fully Liquidated

Posted on Tue, Sep 03, 2013 ©2021 Drucker & Scaccetti


The New Jersey Tax Court recently held that a taxpayer who owned an interest in a partnership could not use prior year unused losses to offset a gain from the sale of the partnership’s only asset.  In the case DiNallo v. Director of Taxation, N.J. Tax Court Case Docket No. 017895-2009, the taxpayer had an interest in a limited liability partnership (“LLP”) whose only asset was land.  In 2004, the LLP sold the land and the partner received a New Jersey K-1 that reported her share of New Jersey gross income for the year.  The partner had received New Jersey K-1s in prior years which indicated losses from this LLP. 


For New Jersey gross income tax purposes, any loss in any category of income in a given taxable year can only be applied against income in that same category in the same taxable year.  The taxpayer was unable to utilize any losses from this LLP in prior years.


However, the taxpayer claimed that she had, in effect, relinquished her interest in the LLP because the LLP sold its only asset, the land.  Citing a New Jersey Supreme Court ruling, Koch v. Director of Taxation, 157 .N.J.1 (1999), she argued she was entitled to claim unused prior year losses as a basis adjustment and reduce her gain from the land sale.  However, the Tax Court agreed with the Division of Taxation because the taxpayer had not entirely disposed of her interest in the partnership, basis adjustments for the prior year’s unused losses in 2004 were not allowed.


The Tax Court analyzed the Koch case which requires that the taxpayer fully dispose, by sale, exchange, or other disposition, a partnership interest in order to utilize prior unused losses.  Although the LLP sold its only asset in 2004, it continued to be in existence and file partnership tax returns for the next year. Therefore, the court ruled that the taxpayer had not fully disposed of her interest in the LLP.


Tax Warrior Perspective

Had the LLP fully liquidated and filed a final tax return in the year of the sale of the property, the taxpayer may have been able to use the disallowed losses as a basis adjustment to offset the gain.  This demonstrates why careful tax planning and strategy implementation is very important.  Of course, we do not know if there was a separate business reason to keep the LLP legally open, but if we assume there was not, Ms. DiNallo clearly lost an opportunity to increase the tax efficiency of the land sale transaction.


Like many Tax Court rulings, the details are highly technical and hard for the non-tax professional to understand and apply to their own scenario.  Contact your tax advisor before you attempt to apply a ruling like this to your own tax situation. If you’d like a fresh perspective on your tax planning, contact us via the “Ask A Tax Warrior” button below. At Drucker & Scaccetti, we are always prepared to help you with this or any other tax-related matter.

Topics: NJ, Koch, Dinallo, Director of Taxation, LLP, Basis adjustment, unused losses, New Jersey, tax court, partnership

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