Avoiding a deemed sale under sec. 751 when admitting a new partner.

• Author: Ellentuck, Albert B.

Facts

The Gamma Consulting Co. is a cash-basis partnership with two partners, Steve and Stuart. The partnership is considering admitting a new partner, Mary, for a contribution of $9,000 and her assumption of an equal share of the partnership debt. The balance sheet on the date of Mary's admission to the partnership is illustrated in the chart at right.

Gamma Consulting Co. Balance Sheet

Fair Adjusted market basis value Cash $ 3,000 $ 3,000 Accounts receivables -- 12,000 Fixed assets (net of depreciation) 21,000 21,000 $24,000 $36,000 Note payable $18,000 $18,000 Capital: Steve 3,000 9,000 Stuart 3,000 9,000 $24,000 $36,000

Steve and Stuart want to know if there will be any adverse tax effects if they admit Mary to the partnership.

Issue

What are the tax effects on Gamma, Steve and Stuart from Mary's proposed contribution?

Analysis

Sec. 721(a) provides that no gain or loss is recognized by a partnership or the contributing partner on a contribution of property to a partnership. However, several other Code sections can combine to cause gain to be recognized when the partnership has an interest in Sec. 751 assets.

Sec. 751(b)(1)(B) provides that if a partner receives cash in exchange for an interest in Sec. 751 property, a deemed sale occurs between the partnership and the partner. Although Steve and Stuart are not receiving any cash on Mary's admission to Gamma, they will be deemed to receive a cash distribution due to the reduction in their shares of partnership liabilities. To the extent that the deemed cash distribution is considered to be in exchange for Sec. 751 property, Steve and Stuart may have to recognize gain or loss.

The cash-basis receivables of Gamma clearly satisfy the definition of Sec. 751 property. As a result of the proposed admission of Mary, Steve and Stuart receive a deemed...