Exam No. 4914

§ 721 provides that A, B, C, and the partnership will not recognize gain on the contribution of property to the partnership in exchange for the partnership interest. A will get 30K basis for her contribution of cash under § 722. The partnership gets inside basis of 30K under § 723.

The partnership's basis in Blackacre will be $40K, which is B's adjusted basis in the property at the time of contribution. §723. Furthermore, B's initial basis under § 722 will also be $40K. However, there will be an adjustment for the debt.

When a partner contributes property which is subject to a liability, the partnership is considered to have assumed the liability to the extent that it does not exceed the FMV of the property at the time of the contribution. § 752(c). Since this liability is a recourse liability, the partners' shares of such liability are determined under the economic risk of loss analysis. § 1.752-2(a).

Here, the partnership is considered to have assumed the $60K liability, and B's personal liabilities are decreased by $60K. Under the economic risk of loss analysis, B remains personally liable for the debt, and C is also liable as a general partner. With respect to B, Reg. § 1.752-1(f) provides that if both an increase and a decrease in a partner's share of partnership liabilities occurs in a single transaction, only the net increase or decrease is taken into account. Thus B has a net decrease in liability in the amount of $30K (60K debt relief - 30K share of partnership liability). C's share of the liability is ½ of 60K, or 30K. Under § 752(a), an increase in a partner's share of liabilities is considered a contribution of money which increases the partner's share of outside basis under § 722. Thus C's outside basis is increase in the amount of $30K for his share of liability. A decrease in a partner's share of partnership liabilities is considered under § 752(b) to be a distribution of money which decreases the partner's outside basis under § 705(a) and § 733. Thus B's net decrease of $30K would lower his outside basis in the amount of $30K.

§ 721 does not provide for nonrecognition for contributions of services. Thus C will have tax consequences under §§ 61 and 83 when the interest is either transferable or no longer subject to a substantial risk of forfeiture. The amount of income is equal to the FMV of the capital interest when it is included in income less any amount paid by the partner. § 83, § 1.721-1(b)(1) (note: I say capital interest because such is typically defined as an interest in both assets and future profits, which is what C is getting).

When a capital interest is transferred in exchange for services, the partnership usually gets to take a §162 deduction for the amount of ordinary income that is includable in the partner's income in the taxable year that the income is recognized; HOWEVER, when the nature of the services are relating to organizational expenses, e.g., startup costs, then the partnership must amortize the expense. See § 83(h), Reg. §§ 1.83-6(a)(4); 1.721-1(b)(2); 1.707-1(c).

Because the partnership is transferring a capital interest for services, it is treated as transferring an individual interest in each of its assets to the service partner and must recognize any gain or loss inherent in the transferred portion of each asset. §1.83-6(b); See also McDougal. Partner C is then treated as transferring back the assets to the partnership in a tax free §721 transaction.

Thus the partnership would amortize the $20K as services paid to C for work on the start up, and C would be deemed to transfer that amount back in under § 721, getting basis under § 722. There is 50K of gain in Blackacre which means that the partnership would have to recognize one third of the gain on such property. And because Blackacre was contributed by B with 704(c) built-in gain, B would be the one to receive the allocation of such gain. The property's inside basis would be increased by the amount of gain allocated to B. Furthermore, B's outside basis would be increased as result of the allocation.
 
 
 

Created by:  bojack@lclark.edu
Update:  31 May 03
Expires:  31 Aug 04