Contribution of Property — 1225 Publ 541 (PDF)

Usually, neither the partner nor the partnership recognizes a gain or loss when property is contributed to the partnership in exchange for a partnership interest. This applies whether a partnership is being formed or is already operating. The partnership’s holding period for the property includes the partner’s holding period.

The contribution of limited partnership interests in one partnership for limited partnership interests in another partnership qualifies as a tax-free contribution of property to the second partnership if the transaction is made for business purposes. The exchange is not subject to the rules explained later under Disposition of Partner’s Inter- est .

Disguised sales. A contribution of money or other property to the partnership followed by a distribution of different property from the partnership to the partner is treated not as a contribution and distribution, but as a sale of property, if both of the following tests are met.

The distribution wouldn’t have been made but for the contribution.
The partner’s right to the distribution doesn’t depend on the success of partnership operations.

All facts and circumstances are considered in determining if the contribution and distribution are more properly characterized as a sale. However, if the contribution and distribution occur within 2 years of each other, the transfers are presumed to be a sale unless the facts clearly indicate that the transfers are not a sale. If the contribution

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and distribution occur more than 2 years apart, the transfers are presumed not to be a sale unless the facts clearly indicate that the transfers are a sale.

Form 8275 required. A partner must attach Form 8275, Disclosure Statement (or other statement), to their return if the partner contributes property to a partnership and, within 2 years (before or after the contribution), the partnership transfers money or other consideration to the partner. For exceptions to this requirement, see Regulations section 1.707-3(c)(2).

A partnership must attach Form 8275 (or other statement) to its return if it distributes property to a partner, and, within 2 years (before or after the distribution), the partner transfers money or other consideration to the partnership.

Form 8275 must include the following information.

A caption identifying the statement as a disclosure under section 707.
A description of the transferred property or money, including its value.
A description of any relevant facts in determining if the transfers are properly viewed as a disguised sale. See Regulations section 1.707-3(b)(2) for a description of the facts and circumstances considered in determining if the transfers are a disguised sale.

Contribution to partnership treated as investment company. Gain is recognized when property is contributed (in exchange for an interest in the partnership) to a partnership that would be treated as an investment company if it were incorporated.

A partnership is generally treated as an investment company if over 80% of the value of its assets is held for investment and consists of certain readily marketable items. These items include money, stocks and other equity interests in a corporation and interests in regulated investment companies (RICs) and REITs. For more information, see section 351(e)(1) and the related regulations. Whether a partnership is treated as an investment company under this test is ordinarily determined immediately after the transfer of property.

This rule applies to limited partnerships and general partnerships, regardless of whether they are privately formed or publicly syndicated.

Contribution to foreign partnership. A domestic partnership that contributed property after August 5, 1997, to a foreign partnership in exchange for a partnership interest may have to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, if either of the following applies.

Immediately after the contribution, the partnership owned, directly, indirectly, or by attribution, at least a 10% interest in the foreign partnership.
The FMV of the property contributed to the foreign partnership, when added to other contributions of property made to the partnership during the preceding 12-month period, is greater than $100,000.

The partnership may also have to file Form 8865, even if no contributions are made during the tax year, if it owns a 10% or more interest in a foreign partnership at any time during the year. See the form instructions for more information.

Basis of contributed property. If a partner contributes property to a partnership, the partnership’s basis for determining depreciation, depletion, gain, or loss for the property is the same as the partner’s adjusted basis for the property when it was contributed, increased by any gain recognized by the partner at the time of contribution.

Allocations to account for built-in gain or loss. The FMV of property at the time it is contributed may be different from the partner’s adjusted basis. The partnership must allocate among the partners any income, deduction, gain, or loss on the property in a manner that will account for the difference. This rule also applies to contributions of accounts payable and other accrued but unpaid items of a cash basis partner.

The partnership can use different allocation methods for different items of contributed property. A single reasonable method must be consistently applied to each item, and the overall method or combination of methods must be reasonable. See Regulations section 1.704-3 for allocation methods generally considered reasonable.

If the partnership sells contributed property and recognizes gain or loss, built-in gain or loss is allocated to the contributing partner. If contributed property is subject to depreciation or other cost recovery, the allocation of deductions for these items takes into account built-in gain or loss on the property. However, the total depreciation, depletion, gain, or loss allocated to partners cannot be more than the depreciation or depletion allowable to the partnership or the gain or loss realized by the partnership.

Example. Areta and Sofia formed an equal partnership. Areta contributed $10,000 in cash to the partnership and Sofia contributed depreciable property with an FMV of $10,000 and an adjusted basis of $4,000. The partnership’s basis for depreciation is limited to the adjusted basis of the property in Sofia’s hands, $4,000.

In effect, Areta purchased an undivided one-half interest in the depreciable property with her contribution of $10,000. Assuming that the depreciation rate is 10% a year under the General Depreciation System (GDS), she would have been entitled to a depreciation deduction of $500 per year, based on her interest in the partnership, if the adjusted basis of the property equaled its FMV when contributed. To simplify this example, the depreciation deductions are determined without regard to any first-year depreciation conventions.

However, because the partnership is allowed only $400 per year of depreciation (10% of $4,000), no more than $400 can be allocated between the partners. The entire $400 must be allocated to Areta.

Distribution of contributed property to another part- ner. If a partner contributes property to a partnership and the partnership distributes the property to another partner

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within 7 years of the contribution, the contributing partner must recognize gain or loss on the distribution.

The recognized gain or loss is the amount the contributing partner would have recognized if the property had been sold for its FMV when it was distributed. This amount is the difference between the property’s basis and its FMV at the time of contribution. The character of the gain or loss will be the same as the character of the gain or loss that would have resulted if the partnership had sold the property to the distributee partner. Appropriate adjustments must be made to the adjusted basis of the contributing partner’s partnership interest and to the adjusted basis of the property distributed to reflect the recognized gain or loss.

Disposition of certain contributed property. The following rules determine the character of the partnership’s gain or loss on a disposition of certain types of contributed property.

Unrealized receivables. If the property was an unrealized receivable in the hands of the contributing partner, any gain or loss on its disposition by the partnership is ordinary income or loss. Unrealized receivables are defined later under Payments for Un- realized Receivables and Inventory Items . When

reading the definition, substitute “partner” for “partner- ship.”

Inventory items. If the property was an inventory item in the hands of the contributing partner, any gain or loss on its disposition by the partnership within 5 years after the contribution is ordinary income or loss. Inventory items are defined later under Payments for Unrealized Receivables and Inventory Items .
Capital loss property. If the property was a capital asset in the contributing partner’s hands, any loss on its disposition by the partnership within 5 years after the contribution is a capital loss. The capital loss is limited to the amount by which the partner’s adjusted basis for the property exceeded the property’s FMV immediately before the contribution.
Substituted basis property. If the disposition of any of the property listed in (1), (2), or (3) is a nonrecognition transaction, these rules apply when the recipient of the property disposes of any substituted basis property (other than certain corporate stock) resulting from the transaction.