I just need help with Part 2

Sally is a 25% partner in the STUV partnership. She has a tax basis in her partnership interest of $300,000. Sally also owns some land and a small building that she would like to sell to the partnership. The property has a fair market value of $500,000. Sally purchased the building for $400,000, and after taking MACRS deductions, her tax basis in the building is $350,000.

Part 1:

If Sally sells the property to the partnership, and the form of the transaction is respected by the IRS, how much taxable income will Sally recognize?

Sallys lawyer, who has a basic understanding of tax law, suggests that Sally should contribute the building to the partnership, and subsequently take a distribution of $500,000 from the partnership. Assuming the form of this transaction is respected by the IRS, how much taxable income will Sally recognize

Part 1 Discussion

In general, the realized gain or loss from a property transaction is measured by the fair market value of the property received less the tax basis of property given up. In this case, Sally will receive $500,000 in cash. Her tax basis in the property she is selling is $350,000. Her gain realized is $150,000. This gain is recognized for tax purposes and reported in taxable income unless you can find a Code section that excludes or defers the gain. Sally will recognize a gain if she sells the property to the partnership.

At first glance, the lawyers suggestion has some merit. If Sally contributes the property to the partnership in exchange for an increased interest in the partnership, Section 721 provides that no gain of loss is recognized. Her basis in her partnership interest is increased by her basis in the property contributed to $650,000 ($300,000 + $350,000). A subsequent distribution of cash to Sally will reduce her basis in the partnership by the amount of the cash distributed to $150,000 ($650,000 - $500,000). Gain is only recognized if the distribution exceeds her basis, which it does not.

It would appear that the lawyers suggestion will work to allow Sally to defer recognition of gain on the transaction.

You discuss this conclusion with the partner in your CPA firm. She states that the substance of both transactions it the same a transfer of property for cash, and is skeptical that the tax law would allow the form of the transaction to be respected in this case. She also remembers from her experience something about disguised sales of property to a partnership. She asks you to check it out.

Part 2

Do you think the lawyers advice will work? In reaching your conclusion please consult the Internal Revenue Code, the Income Tax Regulations and any other primary authority (hint See Code section 707). Also consider the, Additional Limitations to Tax Planning Strategies: Judicially Based Doctrines section of Chapter 3 in the textbook. Use the Thompson Reuters Checkpoint Catalyst Library, and search using the terms, sale of property by a partner to a partnership and disguised sales for your research.

Assume your research yields a conclusion that the second transaction is a disguised sale, can you avoid the disguised sale result by separating the transfer of property to the partnership, and the subsequent distribution of cash? How long do you have to wait?

Prepare a memo explaining your reasoning in a clear concise manner citing appropriate primary authority. Your memo should include quotes from the appropriate section(s) of the Code and Income Tax Regulations.