8535 / Can a partnership carry forward disallowed business interest?

Instead, disallowed business interest is allocated to each partner in the same manner as non-separately stated taxable income or loss of the partnership.¹ The partner is entitled to deduct his or her share of excess business interest in any future year, but only:

(1)   against excess taxable income (see Q ) attributed to the partner by the partnership, and

(2)   when the excess taxable income is related to the activities that created the excess business interest carryforward.²

Such a deduction also requires a corresponding reduction in excess taxable income. Further, if excess business interest is attributed to a partner, his or her basis in the partnership interest is reduced (not below zero) by the amount of the allocation even though the carryforward does not permit a partner’s deduction in the year of the basis reduction. The partner’s deduction in a future year for the carried forward interest will not require another basis adjustment.

If the partner disposes of the partnership interest after a basis adjustment occurred, immediately before the disposition the partner’s basis will be increased by the amount that any basis reduction exceeds the amount of excess interest expense that has been deducted by the partner.³