I am preparing a return for a final year of a partnership that owned real property and sold it this year. The entity has lost money every year, except this year when it has a gain on sale due to previous depreciation. Overall, there has been a loss and the investors are only receiving a fraction of their initial investment. It is clear to me that this is a return of capital, and per the Form 592 instructions, and the wonderful Spidell “Real Estate and Nonresident Withholding” guide, no withholding is needed for a return of capital. However, the 592 instructions show the following in the Q&A section:
109. Is withholding required on distributions that have incurred losses every year?
No. The distributions would be a return of capital if the partnerships have incurred losses every year.
110. When are distributions considered a return of capital as opposed to income distributions? Distributions are deemed first from distributable income and second as return of capital.
My question is, do I have current year distributable income, and since they are deemed to be distributed first, I need to withhold, or, is this a return of capital and no need to withhold?
You are correct, if you have a principal distribution no withholding. That question references instances where you have distributions of both income and principal. Then the income is deemed to be distributed first.