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Section 1.721 of the Department of the Treasury Regulation

Title 26 — Internal Revenue

Chapter I — Internal Revenue Service, Department of the Treasury

Sub Title A — Income Tax

Part 1 — Income Taxes

Normal Taxes and Surtaxes

Partners and Partnerships

Contributions, Distributions and Transfers

Contributions to a Partnership

Updated: Wednesday, September 20, 2006

Section 1.721  — Nonrecognition of gain or loss on contribution

(a) No gain or loss shall be recognized either to the partnership or to any of its partners upon a contribution of property, including installment obligations, to the partnership in exchange for a partnership interest.  This rule applies whether the contribution is made to a partnership in the process of formation or to a partnership which is already formed and operating. Section 721 shall not apply to a transaction between a partnership and a partner not acting in his capacity as a partner since such a transaction is governed by section 707.  Rather than contributing property to a partnership, a partner may sell property to the partnership or may retain the ownership of property and allow the partnership to use it.  In all cases, the substance of the transaction will govern, rather than its form.  See paragraph (c)(3) of Section 1.731-1.  Thus, if the transfer of property by the partner to the partnership results in the receipt by the partner of money or other consideration, including a promissory obligation fixed in amount and time for payment, the transaction will be treated as a sale or exchange under section 707 rather than as a contribution under section 721.  For the rules governing the treatment of liabilities to which contributed property is subject, see section 752 and Section 1.752-1.

(b)(1) Normally, under local law, each partner is entitled to be repaid his contributions of money or other property to the partnership (at the value placed upon such property by the partnership at the time of the contribution) whether made at the formation of the partnership or subsequent thereto.  To the extent that any of the partners gives up any part of his right to be repaid his contributions (as distinguished from a share in partnership profits) in favor of another partner as compensation for services (or in satisfaction of an obligation), section 721 does not apply.  The value of an interest in such partnership capital so transferred to a partner as compensation for services constitutes income to the partner under section 61.  The amount of such income is the fair market value of the interest in capital so transferred, either at the time the transfer is made for past services, or at the time the services have been rendered where the transfer is conditioned on the completion of the transferee's future services.  The time when such income is realized depends on all the facts and circumstances, including any substantial restrictions or conditions on the compensated partner's right to withdraw or otherwise dispose of such interest.  To the extent that an interest in capital representing compensation for services rendered by the decedent prior to his death is transferred after his death to the decedent's successor in interest, the fair market value of such interest is income in respect of a decedent under section 691.

(2) To the extent that the value of such interest is: 

(i) Compensation for services rendered to the partnership, it is a guaranteed payment for services under section 707(c); 

(ii) compensation for services rendered to a partner, it is not deductible by the partnership, but is deductible only by such partner to the extent allowable under this chapter.

(c) Underwritings of partnership interests --

(1) In general. 

For the purpose of section 721, if a person acquires a partnership interest from an underwriter in exchange for cash in a qualified underwriting transaction, the person who acquires the partnership interest is treated as transferring cash directly to the partnership in exchange for the partnership interest and the underwriter is disregarded.  A qualified underwriting transaction is a transaction in which a partnership issues partnership interests for cash in an underwriting in which either the underwriter is an agent of the partnership or the underwriter's ownership of the partnership interests is transitory.

(2) Effective date. 

This paragraph (c) is effective for qualified underwriting transactions occurring on or after May 1, 1996.



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