Contributions to Partnerships

• Pages: 51-74
• Author: James R. Repetti,William H. Lyons,Charlene D. Luke

51

Chapter Four

CONTRIBUTIONS TO PARTNERSHIPS

A. Contributions of Property

1. The Statutory Pattern

Section 721 provides that neither the partners nor the

partnership recognize gain or loss when the partners ex change

“property”

1

for partnership interests.

2

The one exception is that

transfers to investment-company partnerships are taxable.

3

This

exception deters investors from exchanging securities without tax by

contributing them to partnerships.

Transferred pro perty that has a fair market value equal to or

greater than its basis at the time of the transfer keeps its basis in the

hands of the partnership (“inside ba sis”) under § 723. Property that

has a fair market value less than its basis when contributed

generally takes an inside basis in the hands of the partnership equal

to the lower fair market value u nder § 704(c)(1)(C). This special rule

for built-in losses is discussed in detail in Chapter 7 § D. In all

circumstances, the transferor takes a ba sis in the partnership

interest (“o utside basis”) equal to the basis of the property

transferred.

4

The provisions governing transfers to partnerships do not deal

directly with the effect of the transferor’s receiving cash (or other)

“boot” in addition to a partnership interest. Instead, the distribution

of cash or property is governed either by the Code provisions dealing

with distributions or by those dealing with “disguised sales.” Under

§ 733, a cash distribution reduces the partner’s outside basis. The

distribution is tax free unless it exceeds the partner’s outside basis

immediately before the distribution. § 731. (Thi s exception prevents

the distributee from having a negative basis.) If a cash dis tribution

does exceed the transferor’s pre-distribution outside basis, the excess

is taxed as gain fro m the sale of the transferee’s partnership

1

Although in most instances there will be no doubt about whether a partner

has transferred “property,” questions will occasionally arise. Because, as discussed in

§ B, below, services are not “property,” the borderline between “property” and

“services” can be uncertain. For example, a patent, which is the result of a person’s

efforts, is “property,” but a person’s “know-how” in many instances would not be

“property” for purposes of § 721(a). See Rev. Rul. 64–56, 1964–1 C.B. 133.

2

Unlike § 351(a), § 721(a) does not require that the transferors be in “control”

of the partnership immediately after the exchange of property for partnership

interests.

3

§ 721(b).

4

§ 722.

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Contributions to Partnerships

Ch. 4

interest.

5

(This rule differs from that governing the recognition of

gain upon transfers to controlled corporations—that kind of gain is

treated as gain from the sale of the transferred property.) In turn,

§ 741 treats the gain as capital gain.

6

Gain recognized under § 731 does not increase the transferor’s

outside basis.

7

Nor does it increase the basis of partnership assets

unless a basis-adjustment election under § 754 (described in Chapter

10 § B.3 and Chapter 14 § A) is in effect.

8

Example 4-1: Gwen contributes a capital asset with a

value of $102,000, a basis of $10,000, and a holding period

of one month to the GHI partnership. In exchan ge, she

receives $12,000 in cash and a one-third interest in the

partnership. Assume that the $12,000 of cash is properly

determined to be a distribution instead of the proceeds in a

disguised sale. Gwen’s initial outside basis is $10,000 under

§ 722 (the basis of the property she contributed). Because

§ 731(a) treats the $2,000 excess of the cash received over

her outside basis as the proceeds of the sale of a portion of

her partnership interest—a capital asset with a holding

period of less than a year—she recognizes a $2,000 short-

term capital gain. After the dis tribution, Gwen’s outside

basis is zero ($10,000 initial basis under § 722, reduced to

zero by § 733). The partnership’s basis for the asset is

$10,000 under § 723 unless an election under § 754 is in

effect.

The boot transfer may, however, not be a distributio n. Rather,

the receipt of boot may trigger the disguised sale rules of § 707(a)(2),

which are discussed below in § C.1. If the disguised sale ru les apply,

the boot is instead treated a s an amount realized in a partial sale of

the contributed property.

2. Holding Periods

When a partner contributes p roperty that is a capital asset or

property described in § 1231 to a partnership, § 1223(1) requires the

partner to tack the holding period for the capital or § 1231 asset to

the partner’s interest in the partnership. In addition, the

partnership’s holding period in the contributed property is the same

5

§ 731(a).

6

“In the case of a sale or exchange of an interest in a partnership, gain . . . shall

be recognized to the transferor partner. Such gain or loss shall be considered as gain

or loss from the sale or exchange of a capital asset . . . .” § 741.

7

Gain recognized under § 721(b) when property is transferred to an investment

company partnership does increase the transferor’s outside basis. See § 722.

8

§ 743(a). Inside basis does increase when gain is recognized under § 721(b),

which is relevant for contributions to investment company partnerships. See § 723.