An Introduction to Partnership Basis and Limits on Losses

• Pages: 37-50
• Author: James R. Repetti,William H. Lyons,Charlene D. Luke

37

Chapter Three

AN INTRODUCTION TO PARTNERSHIP

BASIS AND LIMITS ON LOSSES

A. The Tax Basis of Partnership Interests and

Partnership Property

Consistent with the pass-through model of taxation, a par tner’s

contribution of prope rty to a partnership is not ordinarily a taxable

event. (The rules for nonrecognition are discussed in Chapter 4). A

partner’s basis for a partnership interest acquired by contributing

property is the same as the basis of the contributed property. The

partnership generally takes the contributed property with the

partner’s basis. See § 721, § 722, and § 723. An exception applies,

however, when the contributed property has a built-in loss. In that

situation, the partnership’s basis is the property’s lower fair market

value. See § 704(c)(1)(C), which is discussed in Chapter 7 § D.

These rules preserve wh atever gain is “built in” to contributed

property so that it will be recognized later—either when the

partnership disposes of the property or when the partner disposes of

the partnership interest. Similar rules preserve pre -contribution

holding periods for capital and § 1231 assets. See § 1223(1) and (2).

Example 3-1: Ellen be comes a partner in the CDE

partnership by contributing a capital asset with a basis of

$40,000 and a value of $50,000. Ellen ’s basis for her

partnership interest is $40,000 under § 722. If she sells her

partnership interest for $50, 000, she will recog nize a

$10,000 gain, just as if she had sold the property.

1

The

partnership’s basis for the asset is also $40,000: if the

partnership sells the asset for $50,000 after Ellen

contributes it, its gain on the sale will be $10,000.

2

The basis of a partner’s interest in a partnership is often called

the partner’s “outside basis.” A partnership’s basis for property it

holds is often called “inside basis.”

To preve nt a partner from being taxed more than once on the

same economic gain, a partner’s outside basis must increase to reflect

that partner’s distributive share of partnership inco me. Similar

considerations require th at a partner’s outside basis be reduced to

1

For a discussion of the character of Ellen’s gain on the sale of her partnership

interest, see Chapter 10 § A.2. See also § 741 and § 751(a).

2

For a discussion of the character of the partnership’s gain on its sale of the

property contributed by Ellen, see Chapter 4 § A.5. See also § 724.