Question

1. Assume your colleague makes the following statement: “The rule that neither the partner nor the partnership recognizes a gain or loss when property is contributed to the partnership in exchange for a partnership interest applies only at the time the partnership is being formed.” Do you agree? If so, why? If not, why not?

Answer 1

No, I do not agree to the statement because when property is contributed to the partnership in exchange for partnership interest then neither the partner nor the partnership recognizes a gain or loss irrespective of whether partnership is being formed or is already operating. The reason for not recognising gain or loss by the partner or the partnership is that the basis the partner had in the property becomes both the partnership's basis in the property and the partner's basis in the partnership interest. For example, if a partner contributes property with a basis of $300,000 and a fair market value of $500,000 to a partnership for 20% interest , partner will have no gain on the contribution because the partnership's basis in the property and the partner's basis in the partnership interest will be $300,000.

But if the property contributed by the partner is subject to debt then the partner may recognize a gain because here it is treated as if the partner is receiving a cash distribution to the extent of debt transferred to other partners in the partnership.For example, if the property contributed by the partner in the above example is subject to debt of $400,000 then the extent of debt transferred to other partners in the partnership is $320,000 ($400,000 * 80%). Therfore, in this case partner will recognize a gain of $20,000 ($320,000 - $300,000) because the liabilities transferred to other partners in the partnership is greater than the partner's basis in the partnership interest.