Reporting UNG Sale Using TurboTax

I am not a tax or investment professional.  I am not qualified to give advice on tax or investment.  No one should follow my steps when preparing his or her tax return.  I am not responsible if you do anyway and get in trouble with IRS or lose money on your investments.

On the other hand, if you are a tax or investment professional, I’d love feedbacks about these partnership ETFs.

Investing in UNG

In 2008 I put some money in UNG, United State Natural Gas Fund. I thought it would be a sure thing. (Recovery always leads to rising energy demand, right?) In December I finally threw in the towel and closed that position with a loss.

When I invested I didn’t know UNG was organized as partnership.  I was surprised when I received a Schedule K-1.  Turns out many commodity and currency funds (USO, UGA, EUO, YCL, for example) are organized as partnerships.

When I sold all UNG shares, I hoped TurboTax could handle the sale easily.  It didn’t, mostly because of the strange quirks and bugs it had.  But after trials and errors, I finally got it to produce a useful tax return.

Better write down everything before I forget.

Schedules K-1 and TurboTax Premier

I used TurboTax Premier 2010 to prepare my return.  I liked its interview feature for Schedules K-1.  Sometimes the questions were confusing, but it asked all the important questions.

Before starting, I imported my 2009 return and updated everything except Schedules K-1.  When TurboTax asked, I told it I would update them later.  When I finished I saved and backed up my return.  This allowed me to go back and restart when mistakes messed things up.

To update UNG K-1, I

1. clicked on the “Federal Taxes” tab.
2. clicked on on the heading “Wages & Income” then on “Explore on My Own” (blue words under the “EasyGuide” button).
3. scrolled down to “Business Income and Expenses” section and clicked on the “Update” button for “Schedules K-1, Q”.  TurboTax changed the button from the usual “Start” to “Update” because I already visited this section once.

The Interview

Many questions in the interview were straightforward.

Q:  Do you want to review schedules K-1 or Q?

A:  Yes.

Q:  Tell us about your Schedules K-1.

A:  I clicked on the “Update” button for partnership/LLCs (Form 1065).  My UNG Schedule K-1 was Form 1065.

Q:  Partnership/LLC K-1 summary (list of Schedules K-1 from 2009).

A:  I clicked on the “Edit” button of UNG to update it.

Q:  Is this information correct?  (verify name of partnership, ID number, ownership)

A:  Part I, Boxes A & B; and Part II, Box F.

Q:  Select the type of partner (limited or general)

A:  Part II, item G.  Most people are limited partners.  General partners run funds like UNG.

First Trick Question

Q:  Describe the partnership. Check any that applies:

• This is a publicly traded partnership;
• This is a foreign partnership
• This partnership ended in 2010
• I received an amended K-1
• None of these apply.

A:  This is the first trick question:

• publicly trade:  in Part I, box D.
• Foreign partnership:  I couldn’t find an answer on UNG K-1, but I was pretty sure the answer was no.
• Amended K-1:  Answer came from the “Amended K-1” check box at the top of the K-1, right above Part III.
• Partnership ended in 2010:  “No” because UNG is still trading?  Wrong!  The correct answer came from the “Final K-1” check box, next to the “Amended K-1” check box.

The statement “This partnership ended in 2010” was misleading.  TurboTax didn’t want to know whether UNG was still active.  It wanted to know whether I sold all my shares.  I did, and I received a final K-1 from UNG.  Why didn’t TurboTax just ask about that?

Checking the “partnership ended in 2010” box led to the next few questions that helped calculating my loss.

Q:  Describe Partnership Disposal

A:  Complete.  My order to sell all shares were executed in full.

Q:  Tell us about your sale

A:  Sold it.

Q:  Enter sales date (and purchase date)

A:  1099-R.

Second Trick Question

Q:  Enter sale prices (price, expense, basis, and gains too)

A:  Tricky because of a software bug.

• Sale price and selling expense:  I had to leave the “Selling Expense” box blank.  The net sales proceeds was entered in the “Sale Price” box.
• Partnership basis:  I entered the amount from Part II, Item L, “Withdrawals & Distributions”, but as a positive number instead of a negative one.
• Ordinary gains:  My UNG K-1 came with a sales schedule.  It reported no gains.
• 1250 gains:  as far as I can tell, not applicable to UNG.

From the information entered TurboTax automatically created a new entry on Schedule D for the sale.  This however became the second entry on Schedule D for my UNG sale.  The first was created when TurboTax downloaded 1099-R from E*Trade.  I deleted the first entry after updating UNG K-1.

The “Selling Expense” box had to be blank because of a TurboTax bug.  Normally, when shares are sold, a broker reports the net proceeds on 1099-R, to be copied to Schedule D.  TurboTax however added the expense to the partnership basis, and copied the gross proceeds to Schedule D.  This created mismatches between 1099-R, of which IRS got a copy, and my Schedule D.  To work around this bug I provided TurboTax with net proceeds and left the expense box blank.

“Partnership basis” was a new concept I had to learn.

Partners generally pay taxes on the partnership’s income annually, whether it is distributed or not.  To avoid double taxation, IRS allows a partner to add his share of income to his original cost basis. (Similarly, a partner is allowed to subtract his share of losses to decrease his cost basis.)  The result is the adjusted basis, from which capital gain or loss is calculated.  In fact, on the sales schedule UNG provided instructions on calculating adjusted basis.

The adjusted basis also appeared on my final K-1.  When I bought shares and became a new partner, UNG created a capital account in which it “deposited” my investment.  From that point gains were added and losses were subtracted.  When I sold my shares, I “withdrew” the remaining capital and the account was closed.  For this reason the amount shown in “Withdrawals & Distributions” matched my adjusted basis.

Passive or Not?

Back to the interview.  Next few interview questions covered income and losses reported in Section III.

Q:  Choose type of activity

A:  Business.  UNG K-1 showed a number in Box 1.

Q:  Enter Box 1 info

A:  OK.  Copy from Box 1.

Here I found another bug.  TurboTax was supposed to find out whether I “materially” participated in the partnership, but that question did not come up.  When I eventually marked the correct answer using TurboTax’s Forms view, the answer didn’t matter anyway.

When a partner materially participates in the partnership, his income or loss is non-passive.  Non-passive losses are reported on Schedule E to offset income, but passive losses can be deducted only  against passive income.  So when a loss is reported in Box 1, it is important to determine whether it is passive.  For UNG, the supplemental information page clearly states:

Under Temporary Regulations Section 1.469-1T(e)(6), none of the distributive share items reported to you on the Schedule K-1 are considered to be derived from a passive activity.

For the last two years I had small losses reported in Box 1.  I wanted to report them on Schedule E, but TurboTax wouldn’t do that automatically.  Instead it marked them as passive loss carryover because I had no other passive income.  Fortunately the amounts were small and I was allowed to deduct them when I closed my UNG position.

Q:  Check boxes that have an amount.

A:  My UNG K-1 had numbers only in Boxes 5, 6a, 11, and 20.

Q:  Enter info from Boxes 4-7

A:  Simple, except the two boxes about interest and dividend from U.S. obligations.  It took me a while to find the answers.  On the supplemental info page UNG reported that 73.42% of interest and dividend was from U.S. Government obligations.

Q:  Enter Box 11 Info

A:  I entered an amount for Code C and another for Code F.  The latter led to the next question.

Q:  Enter Code F detail

• Recoveries
• Section 751(b) gain or loss
• Capital gain that is not portfolio income
• Other non-passive income (loss)
• I have another description item

A:  Because UNG distributions were non-passive, I selected “Other non-passive income”.  This led to two more boxes asking for a description and an amount.  I entered the amount for Code F and a description found (again) on the supplemental info page, “Net ordinary income (loss) from swaps”.

Almost Done

Q:  Enter Box 20 Info

A:  Copy from Box 20.  Straightforward.

Q:  Describe the Partnership (check any that applies)

• Unreimbursed supplemental business expenses
• Passive activity losses from last year
• All investment at risk
• paid health or long-term care insurance

A:  For my UNG partnership, all of my investment wa at risk, and I had passive activity loss carryover.

TurboTax had a pretty good explanation of “at-risk rules”.  (It popped up when I clicked on “Explain this”.)  Basically, the rules say a partner can’t claim losses greater than the maximum he can possibly lose.  For me, that amount was all the money invested in UNG.

TurboTax imported my passive activity loss carryover from 2009 return.

Q:  Report Carryovers – Regular Tax

A:  Default answers imported from 2009 return.

Q:  Any other carryovers?

A:  Default answers again.

Q:  Report AMT carryovers

A:  Default.

Q:  Report other AMT carryovers

A:  Once again, default answers.

That was the last interview question.  However the UNG K-1 was not complete.  Info like capital account analysis was not touched in the interview.  On the other hand TurboTax got all it needed for tax calculation.  To be complete, I switched to the Forms view and updated the remaining fields.

More Questions for New K-1

One week after receiving UNG K-1, I received another K-1.  It was from EUO, ProShares UltraShort Euro.  For this new K-1 the interview flow was slightly different.

Q:  Partnership/LLC K-1 summary (list of my Schedules K-1 from 2009).

A:  I clicked on the “Add Another K-1” button.

Q:  Enter partnership name.

A:  Part I, Box A.

Q:  Enter identification information (ownership and ID number)

A:  Ownership:  Part II, Box F.  ID number:  Part I, Box A.

Q:  Choose the type of partner (limited or general)

A:  Part II, item G.

Q:  Choose the type of partner (domestic or foreign)

A:  Part II, item H.

Q:  Enter the percentage of your share

A:  Part II, item J.

Q:  Enter your liability share

A:  Part II, item K.

Q:  Enter capital account information

A:  Part II, item L.  I made a mistake here initially, entering a positive number for “Withdrawals & Distributions”.  When I double checked, I saw this item looking like this on Schedule K-1:

$(x,xxx)

I completely missed the parenthesis.

Other Thoughts

There is one thing about the ETFs that puzzles me:  When I sold my shares, I expected the capital withdrawn from the partnership to match gross proceeds from the sale.  That didn’t happen.  For UNG I got less.  For EUO I got more.  This seems odd for ETFs as liquid as UNG and EUO.

Update on 04/01/2011

I just looked over the UNG K-1s again.  It didn’t report any capital losses!  None over 2 1/2 years.  Perhaps that caused the difference between capital account and sale price.  I wonder what they do with expiring contracts.