Recognizing when a disguised sale of property takes place.

• Author: Ellentuck, Albert B.

Generally, no gain or loss is recognized when money or unencumbered property is contributed to a partnership (Sec. 721), but this nonrecognition rule does not apply if the transaction is a sale. Disguised sale issues usually arise in the context of a property transfer from a partner to a partnership followed by a cash distribution from the partnership to a partner (or vice versa). If these were treated as separate events, under Secs. 721 and 731 the partner and partnership would not recognize gain or loss on the contribution and distribution. However, this transaction is considered to be a taxable sale of the property under certain circumstances. The transfer constitutes a sale only if both of the following conditions are met (Regs. Sec. 1.707-3(b)(1)):

1. The transfer of money or other consideration would not have been made but for the transfer of the property; and

2. If the transfers are not simultaneous, the subsequent transfer (either of money or property) does not depend on the entrepreneurial risks of partnership operations.

   The following facts and circumstances may prove the existence of a disguised sale (Regs. Sec. 1.707-3(b)(2)):

1. The timing and amount of a subsequent transfer are determinable with reasonable certainty at the time of the earlier transfer;

2. The transferor has a legally enforceable right to the subsequent transfer;

3. The partner's right to receive the transfer of money or other consideration is secured in any manner (taking into account the period during which it is secured);

4. Any person has made or is legally obligated to make contributions to the partnership to permit the partnership to make the transfer of money or other consideration;

5. Any person has loaned or has agreed to loan the partnership the money or other consideration necessary to permit it to make the transfers, taking into account whether any such lending obligation is subject to contingencies related to the results of partnership operations;

6. The partnership has incurred or is obligated to incur debt to acquire the money or other consideration necessary to permit it to make the transfer, taking into account the likelihood that the partnership will be able to incur the debt (considering such factors as whether any person has agreed to guarantee or otherwise assume personal responsibility for the debt);

7. The partnership holds money or other liquid assets, beyond the reasonable needs of the business, which are expected to be available to make the...