As a tax attorney and business attorney, John McGuire frequently works with a partner within a partnership who contributes property to a partnership such as an LLC and the partnership assumes the liability on the property. When this occurs, a tax attorney will advise the contributing partner that their basis is decreased by the sum of the liabilities assumed. Furthermore, a partner’s basis is increased by their share of the partnership liabilities. The examples below should help illustrate this piece of tax law.
For example, assume Joe and Mike form a partnership. Joe contributes property with a basis of $100,000 that is subject to a debt of $60,000, and has a fair market value of $150,000. Mike contributes property with a basis of $40,000 and fair market value of $60,000. Further, assume Joe and Mike are equal partners, each holding a 50% ownership interest in the partnership. Joe’s adjusted basis would be $70,000, calculated: $100,000 basis plus $30,000 share of the $60,000 liability assumed by the partnership less the $60,000 liability ($100,000 + $30,000 – $60,000= $70,000). Mike’s adjusted basis would be $70,000 as well, calculated: $40,000 basis plus $30,000 share of the $60,000 ($40,000 + $30,000).
Under the regulations for IRC Section 722, the tax basis of a partnership cannot be negative. Therefore, if the liabilities assumed by the partnership exceed the contributing partner’s basis in the property the excess is treated as a distribution of cash. For example, if Joe had an adjusted basis of $100,000 in property he is contributing to a partnership, with a $150,000 liability that is assumed by the partnership, the $50,000 of liability in excess of Joe’s basis would be treated as a cash contribution from the partnership to Joe.
Some partner’s have attempted to contribute a promissory note to the partnership to prevent the debt assumed by the partnership exceeding their adjusted basis in the contributed property. The contribution of a promissory note to the partnership does not increase the contributing partner’s basis under IRC Section 722 because the basis in the promissory note would be $0.
The partnership will have a carryover basis and thus the basis in the hands of the contributing partner will be the partnership’s basis in the property contributed. Further, the partnership’s holding period for the property contributed will include the contributing partner’s holding period if the property contributed is a capital asset or is IRC Section 1231 property.
Individuals forming a partnership or contributing property to a partnership should consult with their business attorney and/or their tax attorney to discuss the tax implications to their partnership interest and to the partnership.
Contact The McGuire Law Firm to schedule a free consultation with a tax attorney or business attorney in Denver.