In a partnership, adding a new partner has a number of financial and legal implications. Let’s imagine you and your partners want to add a new partner to the mix. By making a cash contribution, the new partner will have a one-third interest in the partnership. Assume that your basis in your partnership interests is sufficient so that the decrease in your portions of the partnership’s liabilities because of the new partner’s entry won’t reduce your basis to zero.
Gains and Losses when Adding a New Partner
Although adding a new partner may seem straightforward, it’s important to plan the new person’s entry appropriately to avoid tax issues. Here are two points to think about:
- If there’s a change in the partners’ interests in unrealized receivables and substantially appreciated inventory items, the change will be treated as a sale of those items, with the result that the current partners will recognize gain. This includes both accounts receivable and depreciation recapture, as well as certain other ordinary income items. It’s important that those items be allocated to the current partners even after the entry of the new partner in order to avoid gain recognition on them.
- According to the tax code, the “built-in gain or loss” on assets held by the partnership before the new partner was admitted must be allocated to the current partners and not to the new partner. “Built-in gain or loss” refers to the difference between the fair market value and basis of partnership property at the time a new partner is admitted.
Assigning Depreciation
The most notable result of these regulations is that the new partner must be assigned a portion of the depreciation based on his share of the depreciable property’s existing fair market value. This will limit the amount of depreciation that the current partners can take. In addition, when the partnership assets are sold, the built-in gain or loss must be allocated to the current partners. This area of accounting is complex, and partnerships may need to adopt special accounting procedures to comply with the requirements.
Basis can Vary
A partner’s basis in his or her interest might vary often when adding a partner or making other adjustments. It’s important to keep track of your basis since it affects a number of things, including the gain or loss on the sale of your interest, how partnership distributions to you are taxed and the amount of partnership loss you may deduct.
If you need assistance with these or any other difficulties that may emerge as a result of adding a new partner, please contact us.
© 2022. Updated May 2024.