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Cash and Property Contributions to Partnerships and Their Affect on a Partnership Interest

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A partnership is defined to mean the relationship between two or more persons to carry on a trade or business, with each person contributing money, property, labor, or skill, and each expecting to share in profits and losses.  This article will provide a broad overview of some of the tax consequences of cash and property contributions to a partnership (whether upon formation or additional contributions later), the basis of partnership interests received by partners, the basis of contributed property to the partnership, and some other helpful information.

Basis of a Partner’s Interest

The basis of a partnership interest is the cash contributed by a partner, increased by the adjusted basis of any property contributed by a partner. In general, no gain or loss will be recognized when property is contributed by a partner in exchange for an interest in a partnership; however, in certain circumstances (explained further in this article), a partner must recognize gain, and if so, this gain is included in the basis of his or her partnership interest.

Special rules apply to a partner’s contribution to the partnership in the form of assumption of a partnership’s liabilities.

Basis of Contributed Property to the Partnership (Transferred Basis)

For the partnership, the basis of contributed property (for the purpose of determining depreciation, depletion, gain, or loss for the property) will be the same as the partner’s adjusted basis for the property as of the date it was contributed, increased by any gain that must be recognized by the partner.

Contribution of Property- Top Three Exceptions to General Recognition Rules

As mentioned above, usually no gain or loss will be recognized by either a partner or partnership when property is contributed to a partnership in exchange for an interest in the partnership. This general rule applies to both situations where a partnership is being formed and already existing partnerships.

However, there are some exceptions to this rule, three of which are explained below.

1) Property Subject to a Liability

If a partner contributes property that is subject to a liability, or if a partner’s liabilities are assumed by the partnership, that partner’s basis interest will usually be reduced (but never below zero) by the amount of the liability assumed by the other partners. The partner’s basis should be reduced because the assumption of the liability is treated as a distribution of cash to that partner; the other partners’ assumption of the liability is likely to be treated as a cash contribution by them to the partnership.

In most circumstances, a partner must recognize gain when property is contributed which is subject to a liability, and the resulting decrease in the partner’s individual liability exceeds the partner’s partnership basis.

2) Partnership Would be an Investment Company if Incorporated

Gain will be recognized when property is contributed in exchange for a partnership interest if the partnership would be treated as an investment company, if it were incorporated .

A partnership will usually be treated as an investment company if over 80% of the value of its assets is held for investment, and it consists of certain readily marketable items, such as money, stocks and other equity interests, real estate investment trusts, and interests in regulated investment companies. Whether a partnership will be treated as an investment company or not, is typically determined immediately after the contribution of property.

3) Partnership Capital in Exchange for Services Rendered

In most circumstances, if a partner receives a partnership interest in exchange for services rendered, that partner must recognize compensation income.

Partnership’s Holding Period for Contributed Property

Usually, the partnership’s holding period for contributed property includes the partner’s holding period.

Partner’s Holding Period for Partnership Interest

A partner’s holding period for a partnership interest usually includes the holding period of the property contributed (if the property was a capital asset or Section 1231 asset to the contributing partner).

Treatment of Built-In Gain/Loss to the Partnership

In general, if a partner contributes (non-depreciable) property, and the partnership eventually sells or exchanges the property and recognizes gain or loss, the built-in gain or loss must be allocated to the contributing partner. (If the property is depreciable, detailed rules apply to allocation procedures).

Partner’s Basis Increases/Decreases

A partner’s basis will usually increase by any additional contributions by a partner to a partnership (including an increased share of, or assumption of, a partnership’s liabilities), a partner’s distributive share of taxable and nontaxable partnership income, and in general, a partner’s distributive share of the excess of the deductions for depletion over the basis of depletable property.

In general, a partner’s basis will decrease (but not below zero) by any money (including a decreased share of partnership liabilities, or an assumption of the partner’s individual liabilities by the partnership) and adjusted basis of property distributed by a partnership to a partner, a partner’s distributive share of partnership losses, and a partner’s distributive share of nondeductible partnership expenses that are not capital expenditures (including a partner’s share of any section 179 expenses).

Contact Sherayzen Law Office For Legal and Tax Help Regarding Partnerships

The contribution of property to partnerships and various partnership-partner taxation matters can involve complex issues, and this article only attempts to provide a very general background information that should not be relied upon in forming a partnership, contributing property to the partnership or any other specific taxation aspects. Rather, you should contact Sherayzen Law Office for legal help with this issue. Our experienced business tax firm will guide you through the complex web of rules concerning U.S. partnership formation and taxation matters and help you with your specific needs.

Case Note: Weller v. Commissioner of Internal Revenue

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This brief case note describes one of the recent cases of the U.S. tax court.  This description is not a legal advice and may not be relied upon as such.

On September 20, 2011, the tax court ruled in favor of the taxpayer and found that he engaged in his business activities for profit (see Weller v. Comm’r, T.C.M. 2011-224 (T.C. 09/20/11)).

The main issue in this case was whether the taxpayer engaged in his glider plane-related activities during the years in issue with the objective of making a profit within the meaning of section 183.  After being laid off from Boeing in 2002, the taxpayer decided to start a business where he would off high-performance glider training.  On August 1, 2003, petitioner formed Northwest Eagle Soaring, L.L.C. (“Northwest”), in Washington. Northwest provides private glider flight instruction and glider plane rides. The taxpayer did not prepare a business plan for Northwest.

The taxpayer is licensed by the Federal Aviation Administration (FAA) as a Certified Flight Instructor Airplane, Certified Flight Instructor Instruments, and Certified Flight Instructor Glider. Petitioner performed flight instruction for the Boeing Employees Soaring Club.

In late 2003, the taxpayer used money he inherited to complete his purchase of a DG-1000 high-performance glider plane for $180,000, and he placed it in service on November 22, 2003. Northwest conducts its activities primarily on weekends from March through November. Glider flights are restricted to times of good visibility. For business promotion, Northwest maintains a Web site, distributes marketing flyers to locations such as airports and aviation-related businesses, and advertises in a flying publication. The taxpayer  maintained flight logs for the glider activities as required by the FAA.

In 2004, the taxpayer focused his time on the Northwest activities and did not have other employment.  For the years 2005-2007, he worked for other companies, but still deducted unreimbursed employee expenses related to Northwest.

The IRS audited the tax returns for the years 2005-2007 and found that the taxpayer did not have a profit-making objective (i.e. that his Northwest activities were just a hobby).

The tax court disagreed. After finding that the taxpayer’s subjective intent to make profit is the focus of the test, the court looked in detail at the factors provided by the IRS regulations to determine such intent (Section 1.183-2(b)).   There were nine relevant factors: (1) The manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that the assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other activities for profit; (6) the taxpayer’s history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, that are earned from the activity; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved in the activity.

Upon careful application of the facts to these nine factors, the court found that the taxpayer engaged in the glider activities with the primary purpose and intent of realizing an economic profit independent of tax savings during the years in issue.

Contact Sherayzen Law Office For Tax Court Representation

If you disagree with the IRS determination in your case and wish to challenge it the Tax Court, contact Sherayzen Law Office for diligent, zealous, and affordable tax court representation.

U.S. Taxation of Foreign Persons: General Overview

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Unlike U.S. citizens, U.S. resident aliens and domestic corporation which are taxed under the Internal Revenue Code on their worldwide income, the IRS applies a special tax regime to foreign persons. The general rule (subject to numerous exceptions) is that foreign persons are only taxed on their U.S.-source income of specified types and income effectively connected (or treated as “effectively connected”) with a trade or business conducted by such foreign persons within the United States.

For example, generally, capital gains which are not effectively connected with a U.S. trade or business are not subject to U.S. income tax. Be careful, though, because even this seemingly simple rule contains conceptions. The most common exception can be found in IRC Section 871(a)(2). Pursuant to this provision, net capital gains from U.S. sources are taxable to nonresident alien individuals who are present in the United States for 183 days or more during a taxable year even if the gains are not effectively connected with the conduct of a U.S. trade or business.

One can distinguish three main categories of income which is relevant to determining the taxation of foreign persons – effectively connected income, fixed and determinable annual or periodical income, and U.S. source capital gains. Each of these three categories follows specified rules and contains numerous exceptions. Moreover, often, these provisions have to be coordinated with the other provisions in the IRC.

Contact Sherayzen Law Office to Understand Your U.S. Tax Liability

The taxation of foreign persons is a very complex tax question, and this article only attempts to provide a very general background information that should not be relied upon in making the determination of your U.S. tax liability. Rather, you should contact Sherayzen Law Office for legal help with this issue. Our experienced tax firm will guide you through the complex web of rules concerning U.S. taxation of foreign persons, and help you determine your U.S. tax liability.

Non-recognition Transactions Involving Foreign Corporations: Top Three Reporting Requirements

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When we are talking about nonrecognition transactions, we generally mean mergers, spinoffs, and contributions of capital. When such transactions involve foreign corporations, U.S. tax laws impose a number of reporting requirements.

In this brief essay, I will generally discuss the top three reporting requirements for U.S. persons who are involved in nonrecognition transactions involving foreign corporations.

First, IRC Section 6038B and corresponding IRS regulations require that certain information be reported to the IRS on Form 926 for outbound transfers. This means that Form 926 may be required where a U.S. person transfers (or is deemed to transfer) property, including cash, to a foreign corporations. In some case, a similar requirement applies when a foreign corporation is transferred in a IRC Section 355 transaction, such as a spinoff, to certain other foreign or domestic persons (there are also special rules involving transfers to foreign partnerships). Also, keep in mind that a transfer of intangible property to a foreign corporation may also result in additional filing requirements. Other transfers, such as indirect stock transfer, may create a deemed transfer to a foreign corporation.

The second group of requirements is centered around the tax-free transfer of the stock of a domestic corporation to a foreign corporation. IRC Section 367(a) and attendant regulations required the transferred U.S. target to give notice.

The third group of requirements concerns foreign corporations that participate in certain tax-free inbound and foreign-to-foreign reorganization. Pursuant to IRC Section 367(b), the IRS regulations required notice to be filed with the IRS with respect to such reorganizations.

Contact Sherayzen Law Office For Legal Advice Regarding Non-Recognition Transactions Involving Foreign Corporations

This brief essay only provides some of the contours of the reporting requirements regarding non-recognitions transactions involving foreign corporations; it should not be relied upon in determining your IRS reporting requirements.

Rather, if you have any questions with respect to your reporting requirements involving such transactions with respect to foreign corporations, you should contact Sherayzen Law Office. Our experienced international tax firm will assist you in identifying your IRS reporting requirements and help you comply with them.

Who Must File Form 8858

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If a U.S. person owns or is considered to be the owner of a Foreign Disregarded Entity (“FDE”), then he must file Form 8858. In general, there are three different groups of persons who may be required to file the Form.

1. Direct “Tax Owners” of FDE

The instructions to Form 8858 define a “tax owner” as a “person that is treated as owning assets and liabilities of the FDE for the purposes of U.S. income tax law.” Thus, this group of filers includes U.S. persons who are direct owners of FDEs for U.S. tax purposes. For example, a natural person A owns 100% of FDE; therefore, A is required to file Form 8858.

2. Category 4 and 5 Filers of Form 5471 With Respect to a CFC That Owns the FDE

The second group of filers includes U.S. persons that are either category 4 or 5 filers of Form 5471 with respect to a controlled foreign corporation (“CFC”) if the CFC is the tax owner of the FDE.

3. Category 1 and 2 Filers of Form 8865 With Respect to CFP That Owns the FDE

Finally, the third group of filers includes U.S. persons that are either Category 1 or 2 filers of Form 8865 with respect to a controlled foreign partnership (“CFP”) if the CFP is the tax owner of the FDE.

Multiple Filers Exception

In some cases, a multiple filers exception may apply in order to avoid unnecessary filing of the same information. This exception works in conjunction with Forms 5471 and 8865 instructions for multiple filers of same information.

Contact Sherayzen Law Office To Determine Whether You Must File Form 8858

This article contains only general background information and should not be relied upon to determine whether you are required to file Form 8858.

If you are unsure about whether you must file Form 8858, contact Sherayzen Law Office for legal advice. Our experienced international tax firm will help you comply with your U.S. tax reporting obligations, including the determination of whether you are required to file Form 8858.