Question

1. Ryce contributes nondepreciable property with an adjusted basis of $60,000 and a fair market value of $95,000 to the Montgomery Partnership in exchange for a one-half interest in profits and capital. In the next tax year, when the property’s fair market value is $100,000, the partnership distributes the property to Jarvis, the other one-half partner. Jarvis’s basis in the partnership interest was $100,000 immediately before the distribution.

   Which partner must recognize a gain, what is the amount recognized, and what is the effect on that partner’s basis in the partnership interest? What is the effect on Jarvis’s basis in the nondepreciable property received?

Answer 1

In this case Ryce will have to recognize $35,000 as built-in gain in the year in the next year.

This is because taxable gains arise on a distribution of property to a partner where pre-contribution (or built0in) gain exists. In other words if a partner contributes appreciated property to partnership then the contributing partner will recognize gains in the following two situations:

• If the contributed appreciated property is distributed to another partner within seven years of the contribution date, the contributing partner recognizes the remaining net pre-contribution gain on the property.
• In the next situation the partnership distributes any property other than cash to a partner within 7 years after the date of that partner’s contribution to the partnership.

In this case because of the above two conditions the built-in gain on the property is taxable to Ryce. As such Ryce will have to pay tax on $35,000 (95,000 – 60,000) in next year i.e. the year the property was distributed to Jarvis.

Ryce increases his basis in his partnership interest by the $35,000 gain recognized. Jarvis also increases his basis in property received by $35,000.