Form 541 - Partnerships - Department Of Treasury Internal Revenue Service

eral Depreciation System (GDS), she would

exceeded the property’s fair market value

cause of an assumption of partnership liabilities

have been entitled to a depreciation deduction

immediately before the contribution.

is considered a contribution of money to the

of $500 per year, based on her interest in the

partnership by the partner.

4) Substituted basis property. If the dispo-

partnership, if the adjusted basis of the property

sition of any of the property listed in (1),

equaled its fair market value when contributed.

Interest acquired by gift, etc. If a partner

(2), or (3) is a nonrecognition transaction,

(To simplify this example, the depreciation de-

acquires an interest in a partnership by gift,

these rules apply when the recipient of the

ductions are determined without regard to any

inheritance, or under any circumstance other

property disposes of any substituted basis

first-year depreciation conventions.)

than by a contribution of money or property to

property (other than certain corporate

However, since the partnership is allowed

the partnership, the partner’s basis must be de-

stock) resulting from the transaction.

only $400 per year of depreciation (10% of

termined using the basis rules described in Pub-

$4,000), no more than $400 can be allocated

lication 551.

Contribution of Services

between the partners. The entire $400 must be

allocated to Sara.

Adjusted Basis

A partner can acquire an interest in partnership

Distribution of contributed property to an-

capital or profits as compensation for services

The basis of an interest in a partnership is in-

other partner. If a partner contributes prop-

performed or to be performed.

creased or decreased by certain items.

erty to a partnership and the partnership

distributes the property to another partner within

Capital interest. A capital interest is an inter-

Increases. A partner’s basis is increased by

7 years of the contribution, the contributing part-

est that would give the holder a share of the

the following items.

ner must recognize gain or loss on the distribu-

proceeds if the partnership’s assets were sold at

tion.

•

fair market value and the proceeds were distrib-

The partner’s additional contributions to

uted in a complete liquidation of the partnership.

A 5-year period applies to property

the partnership, including an increased

contributed before June 9, 1997, or

This determination generally is made at the time

share of or assumption of partnership lia-

under a written binding contract:

of receipt of the partnership interest. The fair

CAUTION

bilities.

market value of such an interest received by a

•

The partner’s distributive share of taxable

partner as compensation for services must gen-

and nontaxable partnership income.

1) That was in effect on June 8, 1997, and

erally be included in the partner’s gross income

•

at all times thereafter before the contri-

in the first tax year in which the partner can

The partner’s distributive share of the ex-

bution, and

transfer the interest or the interest is not subject

cess of the deductions for depletion over

to a substantial risk of forfeiture. The capital

the basis of the depletable property, un-

2) That provides for the contribution of a

interest transferred as compensation for serv-

less the property is oil or gas wells whose

fixed amount of property.

ices is subject to the rules for restricted property

basis has been allocated to partners.

The recognized gain or loss is the amount

discussed in Publication 525 under Employee

the contributing partner would have recognized

Compensation.

Decreases. The partner’s basis is decreased

if the property had been sold for its fair market

The fair market value of an interest in part-

(but never below zero) by the following items.

value when it was distributed. This amount is the

nership capital transferred to a partner as pay-

difference between the property’s basis and its

•

ment for services to the partnership is a

The money (including a decreased share

fair market value at the time of contribution. The

guaranteed payment, discussed earlier.

of partnership liabilities or an assumption

character of the gain or loss will be the same as

of the partner’s individual liabilities by the

the character of the gain or loss that would have

Profits interest. A profits interest is a partner-

partnership) and adjusted basis of prop-

resulted if the partnership had sold the property

ship interest other than a capital interest. If a

erty distributed to the partner by the part-

to the distributee partner. Appropriate adjust-

person receives a profits interest for providing

nership.

ments must be made to the adjusted basis of the

services to or for the benefit of a partnership in a

•

contributing partner’s partnership interest and to

The partner’s distributive share of the part-

partner capacity or in anticipation of being a

the adjusted basis of the property distributed to

nership losses (including capital losses).

partner, the receipt of such an interest is not a

reflect the recognized gain or loss.

•

taxable event for the partner or the partnership.

The partner’s distributive share of nonde-

However, this does not apply in the following

Disposition of certain contributed property.

ductible partnership expenses that are not

situations.

The following rules determine the character of

capital expenditures. This includes the

the partnership’s gain or loss on a disposition of

•

partner’s share of any section 179 ex-

The profits interest relates to a substan-

certain types of contributed property.

penses, even if the partner cannot deduct

tially certain and predictable stream of in-

the entire amount on his or her individual

come from partnership assets, such as

1) Unrealized receivables. If the property

income tax return.

income from high-quality debt securities or

was an unrealized receivable in the hands

•

a high-quality net lease.

The partner’s deduction for depletion for

of the contributing partner, any gain or loss

•

any partnership oil and gas wells, up to

on its disposition by the partnership is ordi-

Within 2 years of receipt, the partner dis-

the proportionate share of the adjusted ba-

nary income or loss. Unrealized receiv-

poses of the profits interest.

sis of the wells allocated to the partner.

ables are defined later under Payments for

•

The profits interest is a limited partnership

Unrealized Receivables and Inventory

interest in a publicly traded partnership.

P a r t n e r ’ s l i a b i l i t i e s a s s u m e d b y

Items. When reading the definition, substi-

partnership. If contributed property is subject

tute “partner” for “partnership.”

A profits interest transferred as compensation

to a debt or if a partner’s liabilities are assumed

2) Inventory items. If the property was an

for services is not subject to the rules for re-

by the partnership, the basis of that partner’s

inventory item in the hands of the contrib-

stricted property that apply to capital interests.

interest is reduced (but not below zero) by the

uting partner, any gain or loss on its dispo-

liability assumed by the other partners. This

sition by the partnership within 5 years

partner must reduce his or her basis because

after the contribution is ordinary income or

the assumption of the liability is treated as a

loss. Inventory items are defined later in

Basis of Partner’s

distribution of money to that partner. The other

Payments for Unrealized Receivables and

partners’ assumption of the liability is treated as

Interest

Inventory Items.

a contribution by them of money to the partner-

3) Capital loss property. If the property was

ship. See Effect of Partnership Liabilities, later.

a capital asset in the contributing partner’s

The basis of a partnership interest is the money

Example 1. John acquired a 20% interest in

hands, any loss on its disposition by the

plus the adjusted basis of any property the part-

a partnership by contributing property that had

partnership within 5 years after the contri-

ner contributed. If the partner must recognize

an adjusted basis to him of $8,000 and a $4,000

bution is a capital loss. The capital loss is

gain as a result of the contribution, this gain is

limited to the amount by which the

included in the basis of his or her interest. Any

mortgage. The partnership assumed payment of

partner’s adjusted basis for the property

increase in a partner’s individual liabilities be-

the mortgage. The basis of John’s interest is:

Page 14

Form 541 - Partnerships - Department Of Treasury Internal Revenue Service - 2002 Page 14

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