Is sec. 704(c) or sale treatment better for a contributing partner?

• Author: Holbrook, Terri L.

Sec. 723's carryover basis rules provide that a partnership's basis for property contributed by a partner is the property's basis in the contributing partner's hands. If the contributed property's basis differs from its fair market value (FMV) at the time of the contribution, income, gain, loss and deductions with respect to the contributed property are allocated among the partners under Sec. 704(c) and the regulations thereunder, to take account of the variation between the property's basis to the partnership and its FMV at the time of the contribution. The purpose of this special allocation of precontribution gain or loss is to prevent artificial shifting of tax consequences among partners.

If property contributed to a partnership is nondepreciable, nondepletable and nonamortizable, this special allocation is made when the partnership disposes of the property. On the other hand, property subject to any type of cost recovery requires a current Sec. 704(c) allocation.

The general rule for depreciation of contributed property by a partnership is that the partnership continues the contributing partner's depreciation. It retains that partner's depreciation elections and whatever life and method the contributing partner used. However, for contributed property, a special allocation of depreciation deductions may be made to the noncontributing partner(s). Depreciation deductions allocated to the noncontributing partner(s) must equal the amount that would be allowed if the partner purchased a direct interest in the contributed property.

Regs. Sec. 1.704-3 provides taxpayers with the following alternative methods for allocating cost recovery deductions for contributed property:

[] The traditional method.

[] The traditional method with curative allocations.

[] The remedial method.

(See the immediately preceding Tax Clinic item,"Sec. 704(c)'s Anti-Abuse Rule: A Practitioner's Guide.")

The most commonly used methods are the traditional and curative allocation methods. Under the traditional method, the total tax allocations to the noncontributing partner(s) of cost recovery deductions must, to the extent possible, equal "book" depreciation allocated to those partners. Book depreciation is the cost recovery of the property's FMV. However, the total deductions allocated to the partners for a tax year cannot exceed the partnership's deduction for that property. Therefore, noncontributing partners do not benefit from their full book deduction if the...