During my years as a BetterInvesting volunteer, I’ve heard some common misconceptions about investment clubs. I’ll discuss some of these that relate to partnership accounting.
One misconception is that the cost basis of the members is associated with specific purchases of units, with each purchase having its own cost basis similar to mutual fund shares. This isn’t true. As general partnerships, investment clubs have different cost basis rules. A member (partner) has a cost basis in the club as a whole rather than for specific purchases. A gain is only realized when members receive more than their total cost basis in the club rather than more than the cost basis in some specific units.
A second misconception is about the ownership of club assets. I’ve heard many times that if a member owns X percent of the club, that member owns X percent of each club asset. The club is a separate legal entity from its members. It’s the club that owns all club assets. This misconception can lead to a lot of unnecessary work for a treasurer at dissolution or for a withdrawal that includes stock transfer.
If this misconception is believed, a club may ask for X percent of each club asset to be transferred to the withdrawing partner. A much easier way is to transfer enough shares of only one or two stocks with enough value to cover the withdrawing partner’s interest.