Formation of the Partnership: Contribution of Property & Basis
At The McGuire Law Firm a Denver tax attorney and Denver business attorney can assist clients with the formation of their partnership and the tax consequences based upon the property contributed by the partners. The article below has been drafted by a tax attorney may be useful when property is contributed to a partnership for a partnership interest.
When a partnership is formed, the partners will generally contribute property to the partnership. Under Internal Revenue Code Section 721, the partners will recognize neither gain nor loss when they contribute property to the partnership in exchange for a partnership interest.
There are exceptions to IRC Section 721. The non-recognition rule of Section 721 does not apply to, the receipt of an interest in partnership capital in return for services that are performed for the partnership or for services to later be rendered, and when the deemed money under IRC Section 731(a)(1) exceeds the sum of the adjusted basis in the property contributed. Further, Section 721 would not apply to a disguised sale under IRC 707(a)(2)(B) where a partner contributed property and received a priority distribution of cash and property within 2 years from the time the original contribution was made to the partnership. You must always consider whether the value of the property contributed is equal to the value of the partnership interest received by the partner.
What constitutes property for purposes of IRC 721? Property includes both tangible (money, personal property & real property) and intangible property. Intangible property would be goodwill, contract right, accounts receivable, patent rights, secret processes and other types of intangible property, but the property must be owned by the partner who transferred the property (transferor) on their own behalf. When looking at property transferred to a partnership, if the property has value separate and apart from the partnership, the property should be considered Section 721 property.
What is the partner’s basis? When a partner contributes property in exchange for a partnership interest, the partner’s basis is the amount of money contributed and the adjusted basis of the property contributed. Thus, a partner receives a carryover basis in their partnership interest for the property they contribute.
When a partner receives a partnership interest for services performed, this service partner’s basis in their partnership interest is the sum of money paid by the partner for their partnership interest and any amount included in income in connection with the interest transferred. This recognition of income will only increase the partner’s basis in the partnership if the gain resulted from the non-applicability of Section 721.
What is the partnership’s basis in the contributed property? The partnership’s basis in the property contributed would be the adjusted basis of the property in the hands of the contributing partner under IRC Section 723. The contributing partner’s basis would be measured or calculated at the time the partner made the contribution to the partnership.
This article was prepared by John McGuire at The McGuire Law Firm. John is a tax attorney and business attorney working with individuals and businesses regarding their tax and business matters. A Denver tax lawyer and business lawyer at The McGuire Law Firm can assist you regarding the formation of partnerships, tax implications of partnership contributions & distributions and partnership transactions.