AICPA Representative Tasks (verbatim). 1. Application, Calculate the tax implications of certain transactions between a partner and partnership (e.g., services performed by a partner) for tax purposes. 2. Application, Calculate a partner's tax realized and recognized gain (loss) on the contribution of noncash property to a partnership, and the partnership's basis in the property contributed. 3. Application, Calculate the tax realized and recognized gain (loss) for both a partnership and partners on a nonliquidating distribution of noncash property, and the partner's basis in the property received. 4.
Transactions between partners and partnerships fall into three categories, each with distinct tax treatment: (1) contributions of property or services to the partnership, (2) distributions from the partnership to partners, and (3) transactions where the partner acts in a non-partner capacity.
Under IRC §721, no gain or loss is recognized when a partner contributes property to a partnership in exchange for a partnership interest. This nonrecognition rule parallels §351 for corporate formations but operates without a control requirement.
Common mistakes
- Recognizing gain on contribution of encumbered property when debt relief is less than basis. Gain is triggered only when the net debt relief (liability assumed minus partner's share of that liability) exceeds the contributing partner's basis. Trap: "any debt relief triggers gain." Correct: compare net debt relief to basis.
- Treating a profits interest for services as immediate income. Under Rev. Proc. 93-27, a profits interest is generally not taxable upon receipt if it relates to future profits only. Trap: "all partnership interests received for services are immediately taxable." Correct: only capital interests (with liquidation value) trigger immediate income.
- Recognizing loss on nonliquidating distributions. Loss is never recognized on a nonliquidating distribution, even if property FMV is less than basis. Trap: "partner can recognize loss when receiving depreciated property." Correct: loss is deferred into the basis of distributed property.
Bottom line
- Section 721 provides nonrecognition on property contributions; partner takes substituted basis in the partnership interest equal to basis of property contributed
- Partnership takes carryover basis in contributed property and tacks the contributor's holding period
- Services exchanged for a capital interest trigger ordinary income equal to FMV; profits interests generally qualify for deferral under Rev. Proc. 93-27
- Guaranteed payments under Section 707(c) are ordinary income to the partner and deductible by the partnership in computing ordinary income
Exam shortcut
"Cash over basis = gain; never loss on operating." For nonliquidating distributions, gain is recognized only when cash exceeds outside basis. Loss is impossible. Memorize: operating distributions defer economic loss into property basis. "Hot assets first, then squeeze." When allocating basis to multiple distributed properties, assign full basis to unrealized receivables and inventory first (up to partnership basis), then squeeze remaining basis into other assets. This two-tier approach prevents over-allocation.
The full lesson (about 2,440 words, 16 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.C3
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