Contributions to a Partnership
At the desk
| Rule | No gain on contributing property for an interest (Sec. 721); carryover basis both ways (Secs. 722, 723) |
| Liabilities | Partner's basis = property basis – the other partners' share of debt on it + partner's share of all partnership debt. Gain if the shifted debt exceeds total basis contributed |
| Services | Capital interest for services = ordinary income at FMV and that is the basis; profits interest = no income, zero basis |
| 7-year rules | Contributed property distributed to another partner (704(c)(1)(B)); contributor receives other property (737) |
| Character | Built-in capital loss stays capital 5 years; built-in inventory gain ordinary 5 years; receivables ordinary forever (Sec. 724) |
| Trap | Contribute, then take cash out = disguised sale; self-executing for transactions after July 4, 2025 |
On this page
- Contribution of Property 15 notes · 3 examples
- Contributions of Services 4 notes
- Partnership Basis when Service is the Contributing Factor vs. Cash or Property Contribution 1 note
- Liabilities 3 notes · 1 example
- Recognized Gain 5 notes · 1 example
Contribution of Property
- Generally, no gain or loss is recognized on the contribution of property in exchange for a partnership interest (Sec. 721). The contribution may occur at the formation of the partnership or after it has been in existence for some time. The rule applies even if the property is appreciated and the partner receives a disproportionate interest.
- Gain or loss is recognized when the following situations occur:
- The contributed property is distributed to a different partner within 7 years of the contribution date. The contributing partner's recognized gain is the lesser of the pre-contribution gain or the gain that would result if the property were sold at FMV (Sec. 704(c)(1)(B)). If there was no precontribution gain, there is nothing to recognize.
- When a partner contributes property to a partnership and immediately receives a distribution, the transaction is essentially a sale. Gain realized is recognized to the extent the contributed property is deemed purchased by the other partners (the disguised sale rule of Sec. 707(a)(2)(B)).
- added 2026 The 2025 act made Sec. 707(a)(2) self-executing ("except as provided by the Secretary") for transactions after July 4, 2025; the disguised-sale and disguised-payment rules no longer depend on regulations being issued.
- Gain or loss is recognized when the following situations occur:
P and Q contributed land with FMVs of $250,000 and $500,000, respectively, each in exchange for a 50% interest in PQ Partnership. PQ mortgaged the land for $550,000 and distributed $250,000 of the proceeds to Q. Q recognizes any gain realized on 50% of the land she contributed. Fifty percent of the adjusted basis (AB) in the land is included in Q's basis in her partnership interest.
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- A partner who contributed property receives a distribution of a different property (other than money) within 7 years of his or her contribution. The contributing partner recognizes gain on the lesser of
- FMV of the distributed property over the partner's basis in his or her partnership interest or
- The difference between the FMV and the AB of the contributed property on the contribution date (Sec. 737).
- A partner who contributed property receives a distribution of a different property (other than money) within 7 years of his or her contribution. The contributing partner recognizes gain on the lesser of
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C is a partner in CD Partnership. CD Partnership holds three assets: property #1, property #2, and property #3. C contributed property #1, with an AB of $5,000 and a FMV of $10,000, to the partnership in the current year. The other two properties were acquired by the partnership. C's basis in his partnership interest is $2,000. In Year 5, C receives property #3 (FMV $8,000) in a distribution from the partnership. C's gain is the lesser of (1) $6,000 ($8,000 FMV property distributed – $2,000 AB in partnership interest) or (2) $5,000 ($10,000 FMV property #1 at contribution date – $5,000 AB property #1 at contribution date). C recognizes $5,000 of gain on the distribution.
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- A partner acts in an individual capacity in a transaction with the partnership.
- The partnership is an investment company (Sec. 721(b)): a contribution that diversifies the partner's holdings of stocks and securities is taxable.
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- Character of contributed property follows it for a time (Sec. 724): a loss on property that was a capital asset to the partner is capital to the extent of the built-in loss for 5 years; gain or loss on contributed inventory is ordinary for 5 years; gain on contributed unrealized receivables is ordinary forever.
Thomas contributed investment real estate with a basis of $50,000 and a FMV of $43,000 to Fog Partnership, a dealer. Two years later Fog sold it for $40,000. The $10,000 loss is $7,000 capital (the built-in loss at contribution) and $3,000 ordinary (the post-contribution decline, which takes its character from the partnership, a dealer).
Contributions of Services
- The value of a capital interest in a partnership that is transferred to a partner in exchange for services is taxable as ordinary income (compensation), in the year received, unless the interest is nontransferable and subject to a substantial risk of forfeiture.
- The income recognized is added to the basis of the partnership interest. A service partner's basis is the income recognized; if the service partner is an existing partner, the amount recognized is added to the old basis.
- A profits interest (a right to a share of future profits only, with no claim on existing capital) received for services is generally not taxed on receipt (Rev. Proc. 93-27) and has a zero basis.
- The partnership deducts or capitalizes the value, as it would a payment to an employee for the same work.
Partnership Basis when Service is the Contributing Factor vs. Cash or Property Contribution
- A service partner's basis equals the income recognized for the interest. A cash or property partner's basis is the cash contributed plus the adjusted basis of the property, and the partnership takes a carryover basis in the property.
Liabilities
- When a partner contributes property subject to a liability or the partnership assumes a liability of the contributing partner, the partner is treated as receiving a distribution of money from the partnership in the amount of the liability shifted to the other partners.
- A distribution reduces the partner's basis in the partnership interest.
- The partner's own share of the liability (as a partner) is a deemed contribution that offsets part of the deemed distribution. Net effect: basis of the property contributed, less the other partners' share of the debt.
John contributed an office building with an AB of $500,000 for a share in the partnership. The office building currently has a mortgage with a balance of $200,000. If the other partners bear the whole mortgage, John's basis in the partnership is $300,000 ($500,000 AB – $200,000 mortgage); if John retains a 25% share of it as a partner, his basis is $350,000.
Recognized Gain
- To the extent liabilities assumed by the partnership (the other partners' share) exceed the partner's aggregate AB in all property contributed, the partner recognizes gain (and basis in the partnership interest is zero). The gain is capital gain and does not increase basis.
- Note that a partner still bears responsibility for his or her share of the liabilities assumed by the partnership.
Albert acquired a 20% interest in a partnership by contributing a parcel of land and $10,000 in cash. At the time of Albert's contribution, the land had a fair market value of $50,000, had an AB to Albert of $20,000, and was subject to a mortgage of $70,000. When Albert became a 20% partner, he was relieved of 80% of the mortgage debt. Thus, 80% of his $70,000 mortgage, or $56,000, is a benefit to Albert because the other partners are assuming part of the mortgage obligation. Therefore, Albert has a recognized gain of $26,000 ($56,000 benefit – $10,000 cash – $20,000 AB of property), and his basis in the partnership is zero.
- My notes from the problems: Curl is relieved of 80% of a $12,000 mortgage, $9,600. AB $8,000 less $9,600 = $1,600 capital gain; basis is zero. The basis of a partnership interest can never be negative.
- Marlene: relieved of 70% of a $40,000 mortgage, $28,000. AB $25,000 less $28,000 = $3,000 capital gain.
- Encumbered property contributed to a partnership: the partner recognizes gain only to the extent the partner is relieved of debt in excess of total basis contributed, counting cash.
Private reference, not client advice. Original notes written 2022–2023 while studying for the SEE Part 2; figures updated October 2026 (Rev. Proc. 2025-32, Rev. Proc. 2026-15, P.L. 119-21). Verify current-year amounts before relying on them.