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Built-In Gain and Built-In Loss Property on Formation of a Partnership: An Exploration of the Grand Elegance of Partnership Capital Accounts

This article is based on a presentation by the author at the University of North Carolina, 2007 J. Nelson Young Tax Institute.Partnerships frequently are formed with an in-kind contribution of property by one or more of the initial partners. Invariably, contributed property will have a value that differs from the contributing partner’s adjusted basis representing built-in gain or loss. The partnership sections of the Internal Revenue Code (the “Code”) contain numerous provisions designed to restrict partners from shifting the tax consequence of the built-in tax gain or tax-loss that is inherent in contributed property. In addition, a partner may be admitted to an existing partnership that has property with a basis that differs from the value of the property on the partnership books, which may in turn differ from the fair market value of the property as determined for calculating the price of admission for the new partner. This circumstance also may shift accrued gains or losses from existing partners to the entering partner. The presence of built-in gains and losses raise wonderfully complex issues regarding the structure of partnerships that challenge even the most sophisticated partnership tax lawyer.