Are property contributions to a partnership tax-free under §721?

The rule No gain or loss is recognized to a partnership or to any of its partners on a contribution of property to the partnership in exchange for an interest in it (26 U.S.C. § 721(a)). This applies to installment obligations too, and whether the partnership is being formed or already operating (Treas. Reg. § 1.721-1(a)).

What carries over

• The partner's basis in the partnership interest is the money and the adjusted basis of the property contributed, plus any gain recognized under § 721(b) (§ 722).
• The partnership's basis in the property is the partner's adjusted basis at the time of the contribution, plus any § 721(b) gain (§ 723).
• Holding periods can carry over too: a partner's holding period in the interest can include the time the partner held a contributed capital asset or § 1231 property, and the partnership's holding period in the property includes the partner's (§ 1223(1), (2)).

The gain is deferred, not forgiven

• Income, gain, loss and deduction on contributed property are shared so as to take account of the difference between its basis and its value when contributed (§ 704(c)(1)(A)): the built-in gain is allocated back to the contributing partner when the partnership sells.
• If the partnership distributes the property to another partner within 7 years of the contribution, the contributing partner is treated as recognizing that built-in gain (§ 704(c)(1)(B)).
• If, within the same 7 years, the contributing partner receives other property in a distribution, the partner can recognize the net precontribution gain (§ 737(a), (b)).

When gain is recognized anyway

• Disguised sale. A transfer of property to the partnership and a related transfer of money or other property back to the partner that, viewed together, are properly a sale are treated as one (§ 707(a)(2)(B)). Transfers within two years of each other, in either order, are presumed a sale unless the facts and circumstances clearly establish otherwise; transfers more than two years apart are presumed not to be. Transfers within two years treated as not a sale must be disclosed to the IRS under § 1.707-8 (Treas. Reg. § 1.707-3(c), (d)).
• Liabilities. When the partnership takes over a liability of the partner (or the property is subject to one), the partner's decrease in liabilities is a distribution of money (§ 752(b)); only the net decrease from the same transaction counts (Treas. Reg. § 1.752-1(f)). Gain is recognized to the extent money distributed exceeds the partner's basis in the interest (§ 731(a)(1)).
• Investment partnership. § 721(a) doesn't apply to gain on a transfer to a partnership that would be an investment company under § 351 if incorporated (§ 721(b)). That generally means the transfer diversifies the transferors' interests and more than 80% of the partnership's assets (by value, excluding cash and nonconvertible debt) are held for investment and are readily marketable stocks or securities, or interests in RICs or REITs (Treas. Reg. § 1.351-1(c)(1), applied by § 721(b)).
• Related foreign partners. For a contribution of "section 721(c) property" to a "section 721(c) partnership", § 721(a) doesn't apply unless the partnership applies the gain deferral method (Treas. Reg. §§ 1.721(c)-2(b), 1.721(c)-3). The rule doesn't apply where the U.S. transferor and related persons own less than 80% of the partnership, and there is a de minimis exception when the built-in gain on all section 721(c) property contributed in the partnership's taxable year is $1 million or less (§ 1.721(c)-2(b), (c)). These are the regulations § 721(c) authorizes for gain that would be included in the income of a non-U.S. person.

What isn't a contribution of property

• Services. To the extent a partner gives up part of the right to be repaid capital in favor of another partner as compensation for services, § 721 doesn't apply: the value of the capital interest is income to the service partner under § 61 (Treas. Reg. § 1.721-1(b)(1)).
• Not acting as a partner. § 721 doesn't apply to a transaction between a partnership and a partner not acting as a partner; § 707 governs it. Substance governs over form, so a "contribution" in return for money or a fixed promissory obligation is a sale or exchange (Treas. Reg. § 1.721-1(a)).

Intangibles: for the regulatory authority to treat intangibles transferred to a partnership as sold, see § 367(d)(3) (§ 721(d)).