Like a corporation, a partnership typically
requires assets to conduct its business operations.
Therefore when a partnership is formed,
the partners often contribute cash and
other assets in exchange for interest in the partnership.
Naturally, this exchange can have
important tax implications for both the partnership and the partners.
In the prior course, you learned that Section 1001(b) generally requires
recognition of a gain or loss from the sale or disposition of property other than cash.
Under this logic, a partner who contributes property to
a partnership in exchange for partnership interests has to
recognize a gain or loss equal to the difference between
the fair market value of the partnership interest and
the adjusted basis of the property transferred.
However, the application of
this general property transaction rule would deter the formation of a partnership.
Like corporate formation, the transfer of property to
a partnership is essentially just a change in the form of the partner's investment.
By opposing a tax cost,
some taxpayers will refrain from making the transfer,
which will impede them from combining assets with
other tax payers to achieve greater economic goals than could be achieved alone.
These economic goals could even lead to
more tax revenue for the federal government down the line.
The application of the general property transaction recognition rule
would also inhibit payment of any related taxes.
For instance, consider the economic wherewithal to pay tax.
An interest in a partnership is generally not an easily marketable asset,
therefore all else equal.
Partners would have to liquidate a portion of
their newly obtained partnership interests to
pay tax on the receipt of the partnership interest.
Again, this might deter the formation of a partnership in the first place.
For these and other reasons,
congress enacted a nonrecognition provision for contributions of
property to partnerships that is similar to Section 351 for corporations.
In this lesson, you will examine
the basic requirements of this non-recognition provisions,
Section 721 nonrecognition of gain or loss on contribution.
Afterwards you will apply the concepts to Sunchaser Shakery,
the same stylized business used in the prior course.
The nonrecognition provision of Section 721(a) states that as a general rule,
no gain or loss shall be recognized to a partnership or to any of its partners in
the case of a contribution of property to
the partnership in exchange for any interest in the partnership.
A contribution of property can occur at any time.
Thus, much like Section 351 in the corporate setting,
this nonrecognition rule applies to contributions
made during partnership formation or at any time thereafter.
However, in contrast to Section 351,
notice that there is no control requirement for partners.
I underline the word property in Section 721(a) for an important reason.
Although the term is not defined in the code,
the courts have relied on the analogous interpretations pertaining to Section 351.
Thus, for purposes of both statutes,
property is defined broadly to include money, inventory,
capital assets, accounts receivable,
patents, and some other intangibles.
Despite no statutory definition,
the treasury regulations state that property for purposes of
Section 721 does not include services rendered to the partnership,
and a partner who receives a partnership interest in exchange for
services generally realizes ordinary income under Section 61.
You will learn more about the contribution of services in the next lesson.
For now, let's stay focused on the effects of the nonrecognition rule.