Partnership Formation

When forming the partnership, partner initially contributes either cash or property for their share of partnership interest.

Tax Consequences: Usually, no gain or loss is recognized by a partner or partnership on the contribution of money or property in exchange for a partnership interest.

Built in gain or loss: Pre contribution Gain or loss is deferred until taxable disposition of:

a) Property by partnership

b) Partnership interest by partner

Basis: Partner's basis in partnership interest = basis of contributed property.

Holding Period: If partner contributes capital assets or 1231 assets, holding period of partnership interest includes holding period of assets contributed.

Example 1-?

A contributes cash?$20,000?and B Contributes Land Adjusted Basis $6,000?and FMV $20,000?which B was holding it for 5 years.

Tax Consequence: No gain of $14,000 will be recognized by partner B when contributing the property into the partnership and it will be considered as BIG for partner B.

Basis: Basis of $6,000 will be transferred to the partnership and it will create both outside basis of B to $6,000 as well as inside basis of partnership in the property to $6,000

Holding period: The holding period starts from 5 years and it has a nature of Long term.

Pre-contribution gain or loss: B is having a pre contribution gain of $14,000 and that will be deferred until taxable disposition of land by partnership or partnership interest by B.

continuing from above example:

Let's assume that partnership sold the land contributed by B after 2 year for $25,000. How much gain or loss allocated to each partner?

The total recognized gain from the disposition is $19,000 (sale consideration $25,000 - Adjusted Basis $6,000)

We may think since A and B are equal partners, we would give equal portion of $19,000 to each.

But it won't work like that when you have BIG (built in gain).

The partner who has BIG has to recognize big portion of gain from the sale of contributed property.

Here, the gain of $19,000 are splitting into two:

1. Pre Contributed or Built in gain: $14,000 will be recognized only by B (difference between AB $6,000 and FMV $20,000 when B contributed)
2. Post Contributed gain:?$5,000 (will be equally given to both the partners since $5,000 is due to increase in FMV after contribution (FMV when contributed $20,000 - FMV when sold $25,000)

Example 2-?

A contributes cash?$20,000?and B Contributes Land AB $30,000?and FMV $20,000?which B is holding it for 5 years.

Tax Consequence: No loss of $10,000 will be recognized by partner B when contributing the property into the partnership and it will be considered as BIL for partner B.

Basis: Basis of $30,000 will be transferred to the partnership and it will create both outside basis of B to $30,000 as well as inside basis of partnership in the property to $30,000

Holding period: The holding period starts from 5 years and it has a nature of Long term.

Pre-contribution gain or loss: B is having a pre contribution loss of $10,000 and that will be deferred until taxable disposition of land by partnership or partnership interest by B.

continued from above

Let's assume that partnership sold the land after 2 year for $15,000. How much gain or loss allocated to each partner?

The total recognized loss from the disposition is $15,000 (sale consideration $15,000 - Adjusted Basis $30,000)

We may think since A and B are equal partners, we would give equal portion of $15,000 of loss to each.

But it won't work like that when you have BIL (built in loss).

The partner who has BIL will get his tax bill reduced when sell the contributed property by partnership or when selling the partnership interest by partner.

Here, the loss of $15,000 are splitting into two:

1. Pre Contributed or Built in loss: $10,000 will be recognized only by B (difference between AB $30,000 and FMV $20,000 when B contributed)
2. Post Contributed Loss:?$5,000 (will be equally given to both the partners since $5,000 is due to decrease in FMV after contribution (FMV when contributed $20,000 - FMV when sold $15,000)