What happens when a partner contributes property?

The general rule

Publication 541 states the rule plainly: usually, neither the partner nor the partnership recognizes a gain or loss when property is contributed to the partnership in exchange for a partnership interest. This applies whether a partnership is being formed or is already operating. The partnership’s holding period for the property includes the partner’s holding period, so a long-held asset does not restart the clock.

This is why putting a building, equipment or an existing business into a new partnership is not a sale for tax purposes even when the property is worth far more than you paid. The tax on the built-in gain is postponed, not erased, and the rest of this page shows where the publication makes it come back.

Basis on both sides of the contribution

The partnership’s basis for depreciation, depletion, gain or loss on contributed property is the partner’s adjusted basis when contributed, increased by any gain the partner recognized at the time of contribution. The partner’s basis in the new partnership interest is the money plus the adjusted basis of contributed property, covered in our basis page. The result is a mirror: the property carries the old basis inside the partnership, and the interest carries the same basis outside it.

Debt on the property is the usual source of gain

If the contributed property is subject to a debt, or the partnership assumes a debt of the partner, the contributor is treated as receiving a distribution of money for the part of the debt the other partners take on. The publication’s example: Ivan contributes property with an adjusted basis of $8,000 and a $4,000 mortgage for a 20% interest. The other partners assume 80% of it, $3,200, so Ivan’s partnership basis is $8,000 minus $3,200, or $4,800. Raise the mortgage to $12,000 and the other partners are treated as assuming $9,600. That is $1,600 more than his $8,000 basis, so his basis is zero and the $1,600 is capital gain from the sale or exchange of a partnership interest. The gain does not increase the basis of his interest. The calculator above runs that arithmetic and also shows the partnership’s basis in the property, which is the adjusted basis plus the gain recognized.

Disguised sales

A contribution followed by a distribution of different property or money to the partner can be recharacterized as a sale if two tests are met: the distribution would not have been made but for the contribution, and the partner’s right to the distribution does not depend on the success of partnership operations. All facts and circumstances count. Transfers within two years of each other are presumed to be a sale unless the facts clearly indicate otherwise, and transfers more than two years apart are presumed not to be a sale unless the facts clearly indicate they are. A partner who contributes property and receives money or other consideration from the partnership within two years, before or after, generally attaches Form 8275 or another statement to the return, with a caption identifying a section 707 disclosure, a description of the transfers and their value, and the relevant facts. The partnership has a mirror obligation if it distributes property and the partner pays it within two years. The publication refers to Regulations section 1.707-3(c)(2) for exceptions.

Investment company partnerships and foreign partnerships

Gain is recognized when property is contributed to a partnership that would be treated as an investment company if it were incorporated. A partnership generally qualifies when over 80% of the value of its assets is held for investment and consists of certain readily marketable items, such as money, stocks and other equity interests in a corporation and interests in regulated investment companies and REITs, tested ordinarily immediately after the transfer. The rule covers general and limited partnerships, private or publicly syndicated. Separately, a domestic partnership contributing property to a foreign partnership may have to file Form 8865 if it owns at least a 10% interest immediately after, or if the property contributed, added to other contributions in the preceding 12 months, exceeds $100,000.

Built-in gain stays with the contributor

When contributed property is worth more or less than its basis, the partnership must allocate income, deduction, gain or loss on it among the partners so as to account for the difference, using a reasonable method (Regulations section 1.704-3). If the partnership sells the property, built-in gain or loss goes to the contributing partner. The publication’s example has Areta contribute $10,000 cash and Sofia contribute depreciable property worth $10,000 with an adjusted basis of $4,000. The partnership can depreciate only the $4,000 basis, which at a 10% rate is $400 a year, and all $400 goes to Areta rather than being split, because the total allocated cannot exceed what the partnership is allowed.

The seven-year and five-year rules

If a partner contributes property and the partnership distributes it to another partner within seven years, the contributing partner recognizes the gain or loss as if the property had been sold at its value when distributed, with the gain measured by the difference between basis and fair market value at contribution. Character also follows the contributed asset: gain on an unrealized receivable is ordinary; gain or loss on inventory the partner contributed is ordinary if the partnership disposes of it within five years; and a loss on a capital asset sold within five years is a capital loss, limited to the amount by which the partner’s basis exceeded fair market value at contribution.

Contributing services is different

Receiving a partnership interest for services is not a property contribution. A capital interest received for services is included in income at its fair market value, generally when it can be transferred or is no longer subject to a substantial risk of forfeiture. A profits interest received for services in a partner capacity is generally not a taxable event, unless it relates to a substantially certain and predictable income stream, is disposed of within two years, or is a limited partnership interest in a publicly traded partnership.

Sources

• IRS Publication 541, Partnerships (12/2025): Contribution of Property (Disguised sales, Form 8275, investment company, foreign partnership, Basis of contributed property, Allocations to account for built-in gain or loss, Distribution of contributed property to another partner, Disposition of certain contributed property); Contribution of Services; Basis of Partner’s Interest (Partner’s liabilities assumed by partnership). Read November 2, 2026.

Edition read: Publication 541 (12/2025), Partnerships, as posted on irs.gov. Rules and dollar amounts can change; check the current publication and the Instructions for Form 1065 for your tax year. This page summarizes the publication and does not replace it. The worked examples with named people are the publication's own; the other examples use made-up numbers to show the arithmetic.