Disallowance of certain partnership loss transfers.

• Author: Schneider, Steven

If a partner contributes property to a partnership, generally, neither the contributing partner nor the partnership recognizes any gain or loss at the time of the contribution. The partnership takes the property, at an adjusted basis equal to the contributing partner's adjusted basis in the property. The contributing partner increases its basis in its partnership interest by the contributed property's adjusted basis. In addition, a partnership does not adjust the basis of partnership property following the transfer of a partnership interest, unless the partnership has elected under Sec. 754 to make basis adjustments.

New Law

Sec. 704(c)(1)(C)--contributions of BIL property: According to AJCA Section 833, a built-in-loss (BIL) may be taken into account only by a contributing partner, not by the other partners. In determining the amount of items allocated to partners other than the contributing partner, the basis of the contributed property is treated as the fair market value (FMV) at the time of contribution. Additionally, if the contributing partner's partnership interest is transferred or liquidated, the partnership's adjusted basis in the property is based on its FMV when contributed, and the BIL is eliminated.

Sec. 743(b)--mandatory application if aggregate BIL exceeds $250,000: Under AJCA Section 833, generally, the Sec. 743 basis adjustment rules are mandatory (rather than being elective, as under prior law), when an interest in a partnership that has a substantial BIL is transferred. For this purpose, "substantial" means that the partnership's adjusted basis in its property exceeds the property's FMV by more than $250,000.

Sec. 734(b)--mandatory application if Sex. 734(b) adjustment exceeds $250,000: AJCA Section 833 states that a basis adjustment under Sec. 734(b) is required for a distribution with a substantial basis reduction. This is a downward adjustment of more than $250,000 that would be made to the basis of partnership assets if a Sec. 754 election were in effect.

Example 1: Partner A contributes property X to partnership PRS when it has an FMV and an adjusted tax basis of $500,000. B and C each contribute $500,000. A later sells its PRS interest to D for $125,000, the then--FMV of A's interest. A recognizes a $375,000 loss on the sale. B's and C's cash was equally invested in properties Y and Z and the FMV of each of PRS's properties has declined by $375,000. Thus, PRS has a substantial BIL in its property at the time A...