AICPA Representative Tasks (verbatim). 1. Application, Calculate the impact on a partner's basis in a partnership for tax purposes resulting from contributions of noncash property, including a partnership's assumption of debt on the contributed property. 2. Application, Calculate the impact on a partner's basis in a partnership for tax purposes resulting from nonliquidating distributions of noncash property. 3.
A partner's outside basis measures the after-tax investment in the partnership. It determines gain or loss on disposition, limits loss deductions, and controls the tax treatment of distributions. Unlike inside basis (the partnership's basis in its assets), outside basis belongs to each partner individually.
KEY: §721 provides nonrecognition on contributions to partnerships. The trade-off is that basis carries over, the partner's outside basis reflects the tax basis of contributed property, not its fair market value.
When a partner contributes property other than cash, the partner's initial outside basis equals the adjusted basis of the property immediately before contribution.
Common mistakes
- Using FMV instead of adjusted basis for contributed property. Section 722 requires the partner's basis to equal the adjusted basis of contributed property, preserving built-in gain for later recognition. Trap: "partner contributes property worth $200,000, so basis is $200,000." Correct: basis equals the property's adjusted basis before contribution.
- Applying ownership percentage to both liability directions. When contributing encumbered property, the decrease equals the full liability; only the increase uses the ownership percentage. Trap: "decrease basis by 40% of the $60,000 mortgage." Correct: decrease by $60,000, then increase by 40% of $60,000.
- Reducing basis by FMV of distributed property. Nonliquidating distributions reduce basis by the partnership's adjusted basis in the property, not FMV. Trap: "land worth $60,000 distributed reduces basis by $60,000." Correct: reduce by the partnership's $25,000 basis in the land.
Bottom line
- Initial outside basis equals cash contributed plus adjusted basis of property contributed (not FMV), reduced by liabilities assumed by the partnership and increased by the partner's share of partnership liabilities
- Contributions of encumbered property create a two-step adjustment: decrease for the full liability transferred, increase only for the partner's allocable share of that liability
- Nonliquidating property distributions reduce basis by the partnership's adjusted basis in the property (not FMV), and the distributee takes that carryover basis limited to outside basis
- Recourse liabilities are allocated to partners bearing economic risk of loss; nonrecourse liabilities follow profit-sharing ratios after accounting for minimum gain
Exam shortcut
Encumbered property formula: Subtract full liability, add back partner's share. Write "−100%, +X%" next to encumbered contribution problems to avoid the asymmetry trap. Debt type quick test: Ask "who pays if the partnership defaults?" If a partner is on the hook, it is recourse to that partner. If only collateral secures the debt, it is nonrecourse and follows profit ratios. Distribution basis floor: Property distributions cannot create negative basis.
The full lesson (about 2,747 words, 18 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.C1
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