You are a sole proprietor and have a business that has incurred NOLs. You choose to change the structure of the business from a sole proprietorship (filing on schedule C of form 1040) to a partnership (filing a 1065 return). Can the NOLs incurred and carried forward from the sole proprietorship be used in later years when the corporation has elected partnership status and brought in partners? Where does the sole prop-incurred NOL appear on the new partnership’s 1065 return? Will the NOL be included as part of the balance sheet in schedule L?
The NOL should stay on the tax return of the sole proprietor prior to the change in structure, as the NOL was incurred when the business was a pass-through entity. These business NOLs will stay on his individual return and carry forward at the individual level. Since S corps and partnerships are pass through entities, he will be able to “use” these NOLs that he incurred as sole business owner once he starts to receive income from the new pass through entity created (the new partnership).
Since both the sole prop and future partnership are treated as “disregarded entities” for tax purposes, neither of them will hold on to NOLs at the company level – they will simply pass these losses onto the owners.
How does this affect the balance sheet on schedule L of the newly formed partnership return? It does not. The past expenses that have led up to the net operating losses have already been rolled up through retained earnings (capital accounts).
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