TAX FILE MEMORANDUM

TAX FILE MEMORANDUM



TAX FILE MEMORANDUM

FROM:

SUBJECT: Tax Memorandum

4-23-2013

Relevant Facts

There is an already formed partnership named AB Partnership where “A” and “B” are partners. A new partner joins “A” and “B” in AB Partnership, “C”. “C” is considered a service providing partner gaining an interest in the partnership by providing past services. There is a §1231 asset used by the partnership which is a dual espresso and knife sharpening machine. The applicable values for the machine are as follows: fair market value is $250,000; cost basis is $150,000; and adjusted basis is $100,000. This all happens in Tax Year 1 and now the tax year has closed. All taxpayers are on the calendar year system.

 

Specific Issues

Will the partnership recognize a gain or loss on the transfer of interest to the service providing partner if it is holding an appreciated or depreciated asset? If the partnership decides to not recognize the gain or loss of the transfer of interest, will it be subjected to the I.R.C. § 6672 substantial understatement interest? Will the tax return preparer be subject to the I.R.C. § 6694 preparer penalty?

Conclusion

AB Partnership should opt for non-recognition of a gain or loss because with little substantial authority on the issue of recognition when a service providing partner is involved, we can interpret the silence of the courts on the issue to be in our favor. In terms of the penalties, we can expect not to be subjected to neither the substantial understatement penalty nor the preparer penalty because there is little authority governing the recognition of gain or loss, we will not be willfully evading payment of tax liability or knowingly reporting and understating tax liability on a return.

 

Support

I.R.C. §721(a) states a gain or loss shall not be recognized if a partner contributes property in exchange for an interest in the partnership. The section mentions the recognition of property in an exchange of interest, but services are not considered property. Also, this section does not address the issue of rendering services in exchange for an interest in the partnership. Prop. Treas. Reg. § 1.721-1 does address the issue of transferring interest for services. Under Prop. Treas. Reg. § 1.721-1(b)(2) there shall be no recognition of gains or losses for a partnership when the transfer of an interest is exchanged for services.

Prop. Treas. Reg. § 1.83-6(b) provides a transferor should recognize a gain to the extent that the transfer amount exceeds the transferor's basis in the property. The partnership transferred a one - third interest to the service providing partner, which gave him a $66,000 basis in the partnership. The interest that was transferred to the service providing partner does not exceed the partnership's basis in the property.

Under I.R.C. § 83(h) the partnership is allowed to deduct the interest in the partnership that was transferred to the service providing partner. McDougal v. Commissioner, 62 T.C. 720 (1974) covers tax issues involving the formation of a joint venture and gain recognition. We will distinguish from McDougal for many ...