What is the result of a contribution of property by a partner to a partnership?
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Partner A transfers land with a fair market value of $25,000 and basis of $18,000 to a p'ship in exchange for a 25 percent interest. The $7,000 built-in gain is not recognized on the transfer regardless of whether the p'ship is newly organized or a going concern. Show
Exceptions to Nonrecognition Rules In certain circumstances, the nonrecognition rules may not apply to the partners due to a variety of reasons. The following situations, discussed in detail later, might cause a taxable event.
Partner P contributes land (fair market value of $10,000--basis of $6,000) and provides $5,000 of services for a 30 percent interest in the PQR partnership. Ordinarily, only the services would be taxable on this transfer-, however, if P receives a $10,000 distribution shortly after making the transfer, or if PQR is designated an investment partnership, then P must also recognize the $4,000 built-in gain on the transfer of the land. Contributions of property with recapture potential Depreciation recapture property A contributing partner who contributes property subject to depreciation recapture does not trigger the recapture unless gain is recognized under Section 731 (a) (i.e., liabilities creating a negative basis). IRC Sec. 1245(b)(3) If gain is recognized under Section 731(a), the amount of recapture is the lesser of:
If no gain is recognized, the adjusted basis of the property contributed carries over to the partnership and the partnership becomes responsible for the depreciation recapture. Regs. Secs. 1.1245-2(c)(2) and 1.1250-3(c)(3) Partner C contributes machinery with a basis of $7,000 and fair market value of $12,000 in exchange for a 25 percent interest. The difference between the value and the basis is due to $5,000 of accelerated depreciation. Since no gain is recognized on the contribution, the $5,000 Section 1245 depreciation recapture potential carries over to the partnership to be borne by all the partners on a subsequent disposition of the asset. Investment or Business Credit Recapture The transfer of Section 38 property to a partnership does not trigger the investment credit recapture if:
Study QuestionsMake your selection by clicking the appropriate response letter. 1. In February of the current year, K contributed a machine ($200,000 market value and $100,000 basis) and cash of $50,000 to KL Partnership in exchange for a 50 percent partnership interest. What is K's taxable gain as a result of the transaction?$ 150,000$ 100,000$ 50,000$ 0Which of the following will not require gain or loss to be recognized in the creation of a partnership?The transfer of a secret process in exchange for a 20 percent partnership interest.The transfer of Exxon stock in exchange for a 20 percent interest in an investment partnership.The transfer of services in exchange for a 20 percent partnership interest.The transfer of property in exchange for a 20 percent partnership interest followed shortly thereafter by a large distribution of cash to the transferor partner. Which of the following statements is correct concerning the transfer of depreciable property in exchange for a partnership interest?Depreciation recapture is the responsibility of the transferor partner. Depreciation recapture and investment tax credit recapture are the responsibility of the partnership. Investment tax credit recapture is the responsibility of the transferor partner.Investment tax credit recapture is the responsibility of the partnership.T transfers a machine to the ABC partnership in exchange for a 30 percent partnership interest. The machine has a fair market value of $40,000; basis of $25,000, and Section 1245 recapture potential of $20,000. With respect to this exchange:T must recognize ordinary gain of $20,000.T will recognize neither gain nor loss.If the partnership sells the machine for $30,000, T must recognize $15,000 of ordinary income.Depreciation recapture is not considered property for purposes of Section 721 and will cause gain to be recognized. Receipt of Partnership Interest for Services The nonrecognition provisions of IRC Sec. 721 do not apply to the transfer of services in exchange for a partnership interest. The taxable partnership interest received in exchange for the services may be a capital interest, a profits interest, or both. A capital interest refers to a partner's entitlement to a portion of the initial and subsequent contributions of capital to the partnership,- in other words, an interest in the assets (net of any liabilities) of the partnership. The receipt of a capital interest is taxable immediately at its fair market value (FMV). A profits interest generally refers to the right to share in the future income of the partnership and in the appreciation in the value of the assets. The receipt of an interest for future profits is usually taxable only when and as those profits are actually realized. At one time, the IRS tried to tax the RECEIPT of a profits interest . This is not the norm, however, due to tremendous valuation problems. But it can happen when the VALUE of the profits interest is evident. A, an attorney, performs legal services for the ABC partnership in exchange for a 20 percent capital interest. The FMV of ABC is $50,000. Accordingly, A must recognize $10,000 (20 percent of $50,000). If the exchange was for a profits interest of 20 percent, the interest is generally not taxed to the partner until such time that the partnership earns a profit. At that time, A will report a 20 percent share of profits (or losses, if any). The Regulations provide that when a partnership interest is exchanged for services, the service partner must recognize income to the extent of the fair market value of the interest received. The value of the interest, so determined, will be recognized by the service partner as compensation. This compensation must be recognized at the time of the transfer if the interest in the partnership is for past services. A transfer conditioned on the performance of future services will be taxed at the completion of such services. The basis to a service partner for a partnership interest is the amount of income recognized. If the service partner is an existing partner, the amount recognized is added to the old basis. The partnership will treat the amount of services performed in exchange for an interest as either a capitalized cost or as an expense item. This treatment will vary depending upon the nature of the services performed. IRC Sec. 707(c) P, a plumber, performs services in exchange for a 20 percent capital interest in the XYZ partnership worth $50,000. If the services are performed prior to the transfer, P must recognize as compensation income $10,000 (20 percent of $50,000). P's basis in XYZ will be $10,000. If the services are for general plumbing services, the partnership will expense the $10,000. If the services are major plumbing repairs, the partnership will capitalize and depreciate the $10,000. Study QuestionsMake your selection by clicking the appropriate response letter.1. . . Which of the following is not true regarding a restricted capital interest given to a service partner? If no election is made, the income is reported by the service partner either when the restrictions are removed or when the Capital interest is received, A service partner who receives a restricted capital interest can elect to be taxed currently rather than when the restriction is removed. If a service partner elects to be taxed currently, the amount of includable income is the value of the interest on the date it was received, determined as if no restriction existed. If a service partner elects to be taxed currently, an offsetting deduction is allowed if the interest is subsequently forfeited 2. . . V is to perform services in exchange for a 20 percent capital interest in a partnership. Both the services and the capital interest are valued at $30,000. However, the agreement between V and the partnership states that the capital interest is forfeited if V violates any part of the service contract during the next five years. V believes the market value of the interest at the end of the fifth year will be $70,000. (Assume this $70,000 value is accurate when choosing among the answers below,) V has a choice of recognizing. $0 now and $70,000 at the end of the fifth year. $30,000 now and $40,000 at the end of the fifth year, $70,000 now and $0 at the end of the fifth year. $70,000 now and $0 at the end of the fifth year. 3. . . T exchanges services for a 20 percent interest in the ABC partnership. The value of the entire partnership is $100,000, Based upon this information, which of the following is true? If the interest is a profits interest, T must recognize $20,000 in the year that the services are performed. If the interest is a restricted partnership capital interest, T must recognize $20,000 in the year the services are performed. If the interest is an unrestricted profits interest, the income will be recognized in the future as profits are recognized. If the interest is an unrestricted capital interest, no income will be recognized until the capital interest is sold or exchanged. 4. In return for services rendered to it by P, the LMN partnership transfers a one-fourth ownership interest to P when it only has one asset, a tract of land with a basis of $25,000 and fair market value of $40,000. The partnership has no liabilities. As a result of this transaction, Partnership LMN has, respectively. Realized === Recognized $15,000 ====$40,000 $ 5,000=====$30,000 General rule: Partnership organization and syndication expenses are not deductible when incurred. Organizational costs may be amortized over a period of not less than 60 months, if the partnership so elects. Syndication fees, under no circumstances, may be amortized or deducted. IRC Sec. 709 Start-up costs are those expenditures that precede organizational expenses, The election to amortize these costs is found outside of Subchapter K. Organizational costs are defined as:
The following items would be classified as organizational costs:
Syndication expenses are defined to include the following items:
Partnerships may elect under Section 195 to amortize start-up expenses over a period of not less than 60 months. These expenditures are defined as any amount paid or incurred in connection with:
These expenses are only amortizable if the amount expended would ordinarily be deductible if paid or incurred in connection with the expansion of an existing business. The election for organizational and start-up costs should be made separately and as an attachment to the initial Form 1065. The election can be in the form of a written statement authorizing the election, or it ran be made as a mathematical computation. Failure to make the election on the initial return will require that these costs be capitalized until such time that the corporation is fully liquidated or terminated. Regardless of whether organizational or start-up expenses are actually claimed on the initial return, a written statement should be attached to the return making the election. In this regard, if subsequent IRS audit adjustments are made in a later year, the 60-month amortization deduction will not be lost as long as the expense was not intentionally ignored. The following items would be classified as organizational costs:
The distinction between organizational expenses and start-up expenses is not always discernible. Therefore, it will be important to make both the election under Sec. 195 and Sec. 709 to protect the partnership from the adverse consequences of having the IRS reclassify the expenditures. Study QuestionsMake your selection by clicking the appropriate response letter. 1. . . Organization costs for an accrual-basis partnership can, if the proper election is made, be amortized over a period of 60 months or more starting with the month the partnership began business if suchcosts were incurred: Within the first 90 days of the initial tax year in which the partnership began business. Before the first day of the tax year in which the partnership begins business. By the due date of the tax return of the partnership for the tax year in which it began business. By the due date (including extensions) of the tax return of the partnership for the tax year in which it began business. 2. . . Which of the following expenses are considered to be organization expenditures eligible for the amortization election under Section 709? Printing of the partnership prospectus. Legal expenses for preparing the partnership agreement. The fee charged by the state to syndicate a limited partnership. Pre-acquisition investigation expenses. 3. . . Which of the following are start-up costs amortizable under Section 195? Amounts paid by an attorney to investigate acquisition of her own practice, Marketing studies to determine the feasibility of a newly formed trade or business. Accounting fees for setting up a bookkeeping system. Preparing employee manuals before a business venture begins. 4. P, a calendar year partnership, elects to amortize $60,000 of organization expenditures under Section 709 for its first tax year beginning July 1, 20X2. The amount of the deduction for 20X2 is: When property is contributed to a partnership in exchange for a capital and profits interest when does the partner's holding period begin for the partnership interest?If the property contributed for the interest was a capital asset or an IRC 1231 asset, the holding period of the partnership interest will include the holding period of the contributed assets. If a partner contributes any other property or money, his holding period will begin on the day after the interest is acquired.
What is the holding period of property contributed to a partnership?The holding period for property is the length of time that the taxpayer owned the property before disposing of it (IRC § 1223 ).
What is basis of assets contributed to a partnership?The basis to a partner of a partnership interest acquired by a contribution of property, including money, to the partnership shall be the amount of money contributed plus the adjusted basis at the time of contribution of any property contributed.
How is gain or loss calculated on contributed property?The amount of built-in gain or loss at the time of contribution is equal to the difference between the property's value and its basis in the hands of the contributing partner.
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