[1] On June 1 of the current year, Kelly received a 10% interest in Rock Co., a partnership, for services contributed to the partnership. Rock's net assets at that date had a basis of $70,000 and a fair market value of $100,000. In Kelly's current-year income tax return, what amount must Kelly include as income from the transfer of the partnership interest? A. $7,000 ordinary income. B. $7,000 capital gain. C. $10,000 ordinary income. D. $10,000 capital gain. The correct answer is C. A. The amount of $7,000 is based on the adjusted basis of the partnership's net assets. B. The amount of $7,000 is based on the adjusted basis of the partnership's net assets, and the amount recognized should be characterized as ordinary income since it is compensation for services. C. An individual must recognize compensation income when a partnership interest is received in exchange for services (whether current or past) rendered [Reg. 1.721-1(b)(1)]. The receipt of a capital interest in a partnership for services must be included in the year of receipt under Sec. 83. The income that should be recognized is the $10,000 ($100,000 x 10%) fair market value of the partnership interest received unless the interest is nontransferable or subject to a substantial risk of forfeiture. The income is ordinary because it is compensation for services. D. Compensation for services is not characterized as a capital gain.