IRC 723: Basis of Property Contributed to a Partnership
Understand how IRC 723 governs the basis of property contributed to a partnership, its impact on partners, and key considerations for tax compliance.
When a partner contributes property to a partnership, tax rules determine how both the partnership and the contributing partner account for its value. These rules affect future tax calculations, including depreciation, gain or loss recognition, and distributions. Understanding these principles is essential to ensure proper tax treatment and avoid unintended consequences.
IRC Section 723 governs how a partnership determines its basis in contributed property, shaping financial and tax outcomes for both the partnership and its partners.
Partnership’s Acquisition Basis
Under IRC Section 723, when a partnership receives property from a partner, it takes on the partner’s adjusted basis at the time of transfer. This carryover basis preserves any built-in gain or loss until a taxable event occurs.
For example, if a partner contributes land with an adjusted basis of $50,000 and a fair market value of $80,000, the partnership’s basis remains $50,000. If the partnership later sells the land for $90,000, it recognizes a $40,000 gain ($90,000 sale price – $50,000 basis), ensuring tax on pre-contribution appreciation is not avoided.
Depreciable property follows the same rule. If a partner contributes equipment with a tax basis of $30,000 and a fair market value of $45,000, the partnership continues to depreciate the equipment based on the $30,000 basis, using the same method and remaining useful life. This prevents artificial increases in depreciation deductions that could distort taxable income.
Treatment of Contributed Property
Once contributed, property is subject to tax rules regarding built-in gains, depreciation schedules, and income or loss allocations.
If the property has a built-in gain or loss at the time of contribution, IRC Section 704(c) requires that the pre-contribution gain or loss be allocated to the contributing partner upon disposition. This prevents tax consequences from shifting to non-contributing partners. For example, if a partner contributes real estate with a basis of $100,000 and a fair market value of $150,000, the $50,000 built-in gain is taxed to the contributing partner. If the partnership later sells the property for $180,000, the additional $30,000 gain is divided among all partners based on ownership percentages.
Depreciation deductions on contributed property must also be allocated properly. Since the partnership inherits the existing depreciation schedule, tax benefits from prior depreciation remain tied to the contributing partner. Partnerships often use special allocation methods, such as the traditional method, the traditional method with curative allocations, or the remedial method under Treasury regulations, to align tax benefits with economic ownership while complying with anti-abuse provisions.
If contributed property is subject to a liability, additional tax consequences arise. If the partnership assumes debt exceeding the contributing partner’s basis in the property, the excess may trigger immediate gain recognition under IRC Section 731. This is common when real estate with significant mortgage debt is transferred, requiring careful planning to avoid unexpected tax liabilities.
Relationship With Partner’s Outside Basis
A partner’s outside basis represents their investment in the partnership and fluctuates based on transactions. When property is contributed, the partner’s outside basis increases by the adjusted basis of the asset.
Subsequent partnership activity affects outside basis. Income allocations increase it, while deductions and distributions reduce it. If a partner’s outside basis falls to zero, further distributions may trigger taxable gain under IRC Section 731. This is particularly relevant in capital-intensive partnerships where distributions often exceed reported income.
Loss limitations also tie directly to outside basis. Under IRC Section 704(d), a partner can deduct partnership losses only up to their basis. If losses exceed basis, they are suspended and carried forward until basis is restored through additional contributions or future income allocations.
Adjustments for Contributed Liabilities
When a partner transfers property to a partnership that is encumbered by debt, adjustments must be made to both the partnership’s basis in the property and the contributing partner’s outside basis.
Under IRC Section 752, if a partnership assumes a liability attached to contributed property, the contributing partner is considered to have received a deemed distribution equal to the amount of debt transferred, reducing their outside basis. If the reduction exceeds their basis in the partnership interest, the excess is recognized as taxable gain, typically as capital gain under IRC Section 731.
The allocation of partnership liabilities among partners also affects basis calculations. Recourse liabilities, where a specific partner bears the economic risk of loss, are allocated to that partner. Nonrecourse liabilities, where no partner is personally liable, are typically allocated based on profit-sharing ratios under Treasury regulations. These distinctions are particularly important in real estate and leveraged investment partnerships, where debt structuring affects tax outcomes.