IRS Schedule D (565) (2022): Capital Gain or Loss

What IRS Schedule D (565) (2022) Is For

IRS Schedule D (565) (2022) is used by partnerships filing a California Partnership Return of Income to report capital gains and losses from the sale or exchange of capital assets. These include investments such as stocks, real estate held for investment, and other securities. The gains or losses are passed through to individual partners via Schedule K-1, which is used on each partner’s California income tax return. Unlike federal returns, California taxes all capital gains as ordinary income without preferential rates.

When You’d Use IRS Schedule D (565) (2022)

This form is used when the partnership has capital transactions that require reporting to the Franchise Tax Board.

• Late or amended filings: If the original Form 565 was filed with errors or omissions, you must submit an amended Schedule D (565) and issue corrected Schedule K-1s to all affected partners.
  
  
• Installment sales: If the partnership sold property under installment terms, gains must be reported using Form FTB 3805E and included on Schedule D lines for either short-term or long-term gains.
  
  
• Special allocations: When gains or losses are specially allocated under the partnership agreement, they are excluded from Schedule D (Form 565) and reported only on the corresponding Schedule K-1.
  
  
• California-sourced gains for nonresidents: Only capital gains from California sources should be reported for nonresident partners, in compliance with the California Revenue and Taxation Code.

Key Rules or Details for 2022

Partnerships filing for the 2022 tax year must be aware of specific state-level requirements that differ from federal tax treatment.

• Capital gains taxed as ordinary income: Under California law, all capital gains are taxed at regular income tax rates, with no special rate applied to long-term gains.
  
  
• California conformity: California conforms to the Internal Revenue Code as of January 1, 2015, which means that federal tax changes made after that date may not be applied when calculating gains.
  
  
• No federal Opportunity Zone deferrals: Gains that qualify for deferral or exclusion under IRC Sections 1400Z-1 and 1400Z-2 must still be reported in full for California tax purposes.
  
  
• Nonresident limitations: Gains and losses for nonresident partners must be computed using only California-source items, in accordance with R&TC Sections 17955 and 18662.
  
  
• Annual franchise tax requirement: All limited partnerships, limited liability partnerships, and REMICs must pay the $800 Franchise Tax, regardless of income or capital gains activity.

Step-by-Step (High Level)

To properly complete IRS Schedule D (Form 565) (2022), partnerships must follow a structured process that aligns with federal returns, but includes significant state-level differences.

1. Start with Form 1065 and federal Schedule D: Prepare the federal return first, as California uses those figures as a starting point for adjustments.
   
   
2. Separate asset types: Use Part I to report short-term capital assets held for one year or less, and Part II for long-term assets held longer than one year.
   
   
3. Include installment sales: Report installment sale gains from Form FTB 3805E on the appropriate short-term or long-term gain line.
   
   
4. Add passthrough gains: If your partnership received capital gains from other pass-through entities, such as disregarded entities or S corporations, those must be reported accordingly.
   
   
5. Enter capital gain distributions: Include any capital gain distributions received from mutual funds, REITs, or other investment vehicles.
   
   
6. Summarize and transfer: Total the short-term and long-term gains separately, and transfer the net figures to lines 8 and 9 on Schedule K-1 (Form 565).
   
   
7. Attach supporting documentation: Submit broker statements and calculations, especially when adjusting basis for California use tax or other state-specific rules.
   
   
8. Issue Schedule K-1s: Provide each partner with a properly formatted Schedule K-1, showing ownership percentages to four decimal places and accurately sourcing gains.

Common Mistakes and How to Avoid Them

Many partnerships encounter recurring issues when completing IRS Schedule D (565) (2022); the following errors can be avoided with proper attention to California-specific requirements:

• Mixing capital and business property: Report business property transactions using Schedule D-1 or Form 4797, not on Schedule D (565), to avoid misclassification and tax miscalculations.
  
  
• Ignoring California adjustments: Recalculate asset basis using California tax rules when they diverge from federal treatment, especially in areas impacted by IRC Section 179 or bonus depreciation.
  
  
• Incorrectly reporting special allocations: Exclude specially allocated gains and losses from Schedule D and report them only on the affected partner’s Schedule K-1, as required under the partnership agreement.
  
  
• Improper sourcing for nonresidents: Include only California-source capital gains on nonresident partners’ K-1s to comply with sourcing rules in the California Revenue and Taxation Code.
  
  
• Formatting errors on K-1s: Use ownership percentages expressed as decimals to four places (e.g., 25.0000%) to meet the formatting requirements of the California Secretary of State.
  
  
• Missed electronic filing requirement: File electronically if the return is software-prepared, unless a waiver has been granted, to avoid penalties under state electronic filing mandates.
  
  
• Late filing without extension: Submit Form FTB 3538 by the original deadline to secure an extension and avoid per-partner penalties for late filing.

What Happens After You File

Once your Form 565 and Schedule D (565) are submitted, the Franchise Tax Board reviews your filing and compares reported gains to those claimed on each partner’s Schedule K-1. E-filed returns usually receive acknowledgment within a few business days, while paper returns may take 4–6 weeks. The FTB may issue notices for mismatched figures, omitted basis adjustments, or errors in ownership percentages. 

If discrepancies arise, the partnership may protest through the FTB 3893 process, and unresolved issues can be escalated to the California Department of Tax and Fee Administration or handled through the administrative appeals process.

FAQs

Do I need to file Schedule D (565) if there were no capital asset transactions during the tax year?

No; if your partnership had no sales or exchanges of capital assets in 2022, you can leave Schedule D (565) blank and exclude it from the California income tax return.

How do I report Qualified Opportunity Zone gains under California law?

You must report the full gain on Schedule D (565), as California does not conform to federal opportunity zone deferral rules under IRC Sections 1400Z-1 and 1400Z-2.

Can a partnership deduct percentage depletion or other resource-based credits on Schedule D (565)?

No, deductions, such as percentage depletion and resource-specific tax credits, are generally claimed elsewhere on Form 565 or Form 8825, not on Schedule D (Form 565).

Are capital gains from repurchase agreements or futures contracts reported on this form?

Yes, if the gains arise from investment securities, such as repurchase agreements, futures contracts, or common and preferred stock, they should be reported on Schedule D (Form 565).

What if our business were to receive relief funds or grants, such as the California Microbusiness COVID-19 Relief Grant?

Such relief grants are not reported on Schedule D (565); instead, they should be disclosed and classified appropriately under the income sections of Form 565 based on grant type and eligibility.