A partner contributes raw land worth $300,000 with an $80,000 basis and a $120,000 mortgage. The numbers ripple through outside basis, debt allocation, and built-in gain accounts in ways that drive almost every partnership question on the SEE.
§721 says no gain or loss on a contribution of property to a partnership in exchange for a partnership interest. The partnership is treated as a continuation of the partner with respect to that property.
Contributing partner's outside basis (§722). Equals adjusted basis of property contributed plus any gain recognized plus money contributed. Reduced by liabilities the partnership assumes (deemed cash distribution under §752(b)). Increased by the partner's share of partnership liabilities (deemed contribution under §752(a)).
Partnership's inside basis (§723). Carryover from the contributing partner plus any gain recognized by that partner. Holding period also tacks.
KEY: Outside basis is the partner's basis in their partnership INTEREST. Inside basis is the partnership's basis in the underlying ASSETS. Aggregate outside bases should equal aggregate inside basis at formation.
Common mistakes
- Forgetting that liability relief is part of amount realized. Selling a partnership interest for $100,000 cash with $50,000 of debt relief means amount realized is $150,000, not $100,000.
- Treating a service-for-capital-interest exchange as nontaxable under §721. The recipient has ordinary income equal to FMV under §83.
- Applying the "substantially appreciated" (greater than 120%) test to sales of partnership interests. That test applies only to §751(b) disproportionate distributions; §751(a) hits ALL inventory on a sale of an interest.
Bottom line
- §721 nonrecognition on property contributions; §83 ordinary income on services contributions (FMV of capital interest received)
- Contributing partner's outside basis = adjusted basis of property contributed + share of partnership liabilities, minus liabilities assumed by the partnership; carryover basis under §722 (partner) and §723 (partnership)
- §704(c) locks pre-contribution built-in gain or loss to the contributing partner; §707 treats partner-partnership dealings as third-party transactions when the partner is not acting in partnership capacity
- Outside basis rises with income, contributions, and §752 liability-share increases; falls with distributions, losses, and liability-share decreases, never below zero
Exam shortcut
Net the §752 numbers first. Liability assumed by partnership is a deemed distribution; partner's share of partnership debt is a deemed contribution. Compute the net before testing for §731 gain. Hot-asset question? Default to §751(a) ordinary. Any sale of an interest with cash-method receivables or appreciated inventory triggers ordinary income up to the partner's share, regardless of holding period or 120% threshold. Guaranteed payment timing.
The full lesson (about 2,268 words, 15 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- 2
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