No gain or loss generally is recognized on a transfer of property to a partnership in exchange for an interest in that partnership for federal income tax purposes (note that “partnership” here includes a limited liability company). Different rules, however, apply when the partnership has foreign partners that are related to the person transferring the property.
Exchanges of Property
When property is exchanged for other property, each party to the exchange generally is taxed on the difference between the fair market value of the property that the party receives over the adjusted basis of the property that the party transfers.[1] A property’s adjusted basis in most cases is the amount paid to acquire it after taking into account such factors as depreciation or amortization.[2] Thus, the transfer of property in exchange for a partnership interest generally would result in the recognition of gain or loss to the transferor and the partnership in the absence of a provision in the Internal Revenue Code preventing this result.
Contributions of Property to a Partnership
Section 721(a) is that provision. This section generally provides that no gain or loss is recognized to the partnership or its partners when there is a contribution of property in exchange for an interest in the partnership. Instead, the person contributing the property takes a basis in the partnership interest equal to the adjusted basis of the property.[3] Likewise, the partnership’s basis in the contributed property is the same as its adjusted basis in the hands of the transferor.[4] These provisions serve to preserve the built-in gain in the contributed property until the partnership sells or otherwise disposes of the property.
Partnerships are not taxed at the entity level.[5] Instead, the partners are taxed on their distributive shares of partnership income, with these shares generally being determined by the partnership agreement.[6]
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