Articles · Advanced · Partnerships and Form 1065
Section 704(c): Built-In Gain on Contributed Property
When a partner contributes property worth more or less than its tax basis, Section 704(c) requires the built-in gain or loss to be allocated back to the contributing partner.
The core idea
Suppose Partner A contributes land worth $100,000 with a $40,000 basis, and Partner B contributes $100,000 cash. The $60,000 built-in gain belongs to A. If the land sells for $100,000, A recognizes all $60,000 of tax gain. Any appreciation after contribution is shared under the agreement.
The ceiling rule
For depreciable property, tax depreciation may be too low to match the book depreciation allocated to the non-contributing partner. Under the traditional method, tax allocations cannot exceed the actual tax item. This limit is the ceiling rule, and it can leave the non-contributing partner short.
The three methods
The traditional method accepts the ceiling rule distortion. The traditional method with curative allocations uses other actual tax items to correct it. The remedial method creates notional offsetting items of income and deduction.
The choice is made property by property and should be reasonable. Partners often negotiate it, because it affects who bears tax. Sections 704(c)(1)(B) and 737 can also trigger gain if contributed property is distributed within seven years.
Key takeaways
- Built-in gain stays with the contributing partner.
- The ceiling rule can distort allocations.
- The method should be agreed at the outset.
For general education only, not tax advice. Tax law changes often, so confirm current rules and amounts with primary sources.