Business Tax Preparation · Advising the business taxpayer

Transfer of property in or out of the business (e.g., contributed property, distributions)

Two questions decide every transfer: is there recognition now, and where does the built-in gain go. The corporate and partnership answers differ at both ends, and the difference is much larger on the way out than on the way in — which is why a structure chosen for its formation treatment often turns out to have been chosen for the wrong reason.

The rule

Into a corporation. no gain or loss is recognised where property is transferred to a corporation by one or more persons solely in exchange for stock and, immediately after the exchange, those persons are in control of the corporation within IRC § 368(c)^TY2026 (IRC § 351(a)), with where other property or money is received in addition to the stock, gain is recognised up to the sum of the money and the fair market value of the other property — and loss is not recognised at all^TY2026 (IRC § 351(b)). The corporation’s basis: the corporation takes the transferor’s adjusted basis in property acquired in an IRC § 351 transaction or as paid-in surplus or a contribution to capital, increased by any gain the transferor recognised^TY2026 (IRC § 362(a)). And the trap that catches real estate: where liabilities assumed exceed the total adjusted basis of the property transferred in an IRC § 351 exchange, the excess is treated as gain from the sale of the property — so a contribution of encumbered property can produce gain with no cash and no boot^TY2026 (IRC § 357(c)(1)).

Into a partnership. no gain or loss is recognised to a partnership or to any partner on a contribution of property to the partnership in exchange for a partnership interest — with no control requirement and no time limit^TY2026 (IRC § 721(a)), with the partnership’s basis the partnership takes the contributing partner’s adjusted basis in the contributed property, increased by any gain recognised under IRC § 721(b)^TY2026 (IRC § 723). Notice the two requirements § 351 imposes that § 721 does not — control immediately after, and the transfer being solely for stock.

Where the built-in gain goes. In a corporation it is simply in the corporation’s basis and surfaces when the corporation sells. In a partnership it is tracked to the contributor: income, gain, loss and deduction on contributed property must be shared among the partners so as to take account of the variation between the partnership’s basis in it and its fair market value at contribution — the built-in gain stays with the contributor^TY2026 (IRC § 704(c)(1)(A)), with an anti-abuse rule — where contributed property is distributed to a partner other than the contributor within 7 years of the contribution, the contributing partner is treated as recognising the gain or loss that the variation would have allocated had the property been sold at fair market value^TY2026 (IRC § 704(c)(1)(B)).

Out of a corporation. a corporation distributing appreciated property to a shareholder recognises gain as if the property had been sold to the distributee at fair market value — while a distribution of depreciated property gives the corporation no loss^TY2026 (IRC § 311(a) and (b)(1)), and the shareholder is then taxed on the distribution under IRC § 301(c) — an amount a C corporation pays a shareholder that is not deductible compensation, rent or interest is a distribution — a dividend to the extent of earnings and profits, then a reduction of stock basis, then gain from the sale of the stock^TY2026. Two levels of tax on one movement of property.

Out of a partnership. a partner recognises gain on a distribution only to the extent money distributed exceeds the adjusted basis of the partnership interest immediately before it, and recognises loss only on a liquidating distribution of money, unrealised receivables and inventory alone^TY2026 (IRC § 731(a)), with basis under property distributed other than in liquidation takes the partnership’s adjusted basis in it, capped at the partner’s adjusted basis in the interest reduced by any money distributed in the same transaction^TY2026 (IRC § 732(a)). No entity-level gain at all.

And liabilities move basis in a partnership. An increase in a partner’s share of partnership liabilities is a contribution of money under IRC § 752(a), a decrease is a distribution under § 752(b) — so encumbered property changes outside basis in both directions.

Current figures

How it works in practice

On the way in, the corporate rule has conditions the partnership rule does not. IRC § 721 asks only that property be contributed for an interest. IRC § 351 asks additionally that the transfer be solely for stock and that the transferors control the corporation immediately afterwards. A later contribution by an existing minority shareholder therefore fails § 351 unless it is part of a larger transaction that satisfies control, while the same contribution to a partnership is straightforwardly non-recognition.

Check basis against liabilities before contributing real property to a corporation. IRC § 357(c) recognises gain to the extent assumed liabilities exceed the total adjusted basis of the property transferred, and depreciated real property with a refinanced mortgage is exactly the fact pattern that produces it. There is no cash, no boot and no economic gain — and there is tax. A partnership contribution has no equivalent, because IRC § 752 puts the liability into outside basis instead.

The built-in gain is the real question, and the two regimes answer it differently. A corporation absorbs it: the property has a carryover basis and whoever bears the tax when it is sold is decided by who owns the stock then. A partnership tracks it: IRC § 704(c)(1)(A) requires income, gain, loss and deduction on contributed property to be allocated so as to take account of the variation at contribution, so the contributor bears their own gain however the interests later change.

Do not distribute appreciated property out of a corporation without pricing it. IRC § 311(b) recognises gain at the corporate level as if the property had been sold at fair market value, and the shareholder is then taxed on the distribution. IRC § 311(a) denies the corporation a loss on depreciated property, so the rule is one-way. A partnership distribution triggers no entity-level gain at all and no partner-level gain unless money exceeds outside basis.

Watch the seven-year window. Distributing contributed property to a partner other than the contributor within seven years accelerates the contributor’s built-in gain under IRC § 704(c)(1)(B), as though the property had been sold. This catches partnerships that reshuffle assets among partners for perfectly ordinary commercial reasons, and it is easy to miss because nothing has been sold and no cash has moved.

Property is much easier to get out of a partnership than out of a corporation. That asymmetry is the single most useful planning point here. A business expecting to hold appreciating property and later move it to the owners should think hard before putting it inside a corporation, because IRC § 311(b) makes the exit expensive and nothing undoes it short of liquidation, which is worse.

Scenarios

Traps

How this has changed

The architecture is old and stable. IRC § 351 and § 721 date from the 1954 Code in substantially their present form, and the divergence between them — control and solely-for-stock on the corporate side, neither on the partnership side — has been there throughout.

The IRC § 704(c) rules have hardened. The remedial and traditional-with-curative allocation methods were regularised by regulation in 1993, and the anti-abuse rule in § 704(c)(1)(B) was extended from five years to seven for property contributed after 2 June 1997, which is the figure a candidate should carry. Material quoting five years is describing pre-1997 law.

IRC § 311(b) is itself a change: before the repeal of the General Utilities doctrine in 1986 a corporation could generally distribute appreciated property without recognising gain, which is why older planning literature treats a corporate distribution of property as unremarkable. It has not been unremarkable for forty years.

Nothing in the post-2024 legislation alters IRC §§ 351, 357, 362, 704(c), 721, 723, 731 or 732. The indirect effect runs through basis: with bonus depreciation permanent at the full statutory rate, property contributed to an entity is far more likely to carry a basis near zero, which makes IRC § 357(c) easier to trigger and IRC § 704(c) allocations larger.

Exam focus

Know the two additional IRC § 351 requirements by name, and that IRC § 721 has neither. Expect a question in which an existing shareholder contributes property and the answer turns on control.

Know IRC § 357(c) precisely: liabilities assumed in excess of the aggregate adjusted basis of the property transferred, treated as gain from the sale of the property. It is the most tested trap in this area.

Keep the two basis provisions straight — IRC § 362(a) for the corporation, IRC § 723 for the partnership — and note that both are carryover with an increase for gain recognised.

For IRC § 704(c), state the principle as an allocation requirement rather than a rate rule, and know the seven-year window and that it is triggered by a distribution to a partner other than the contributor.

Finally, contrast the exits. IRC § 311(b) recognises corporate gain on distributing appreciated property and IRC § 311(a) denies loss; IRC § 731(a) recognises partner gain only where money exceeds outside basis, and no entity gain at all.

Check yourself

1. A person already owning 30 percent of a corporation contributes equipment worth $200,000 with a basis of $80,000 in exchange for additional shares, after which they own 45 percent. Is the transfer tax-free?

Answer: No. IRC § 351(a) requires that the transferors be in control — within IRC § 368(c), at least 80 percent of the voting power and of each other class — immediately after the exchange, and 45 percent is not control. The transferor recognises $120,000 of gain and the corporation takes a cost basis. Had the same property been contributed to a partnership, IRC § 721(a) would have applied with no control requirement at all, and the partnership would have taken the $80,000 carryover basis under IRC § 723.

2. A sole shareholder contributes land with a basis of $50,000 subject to a $180,000 mortgage to a corporation in a transaction that otherwise qualifies under IRC § 351. What is recognised?

Answer: $130,000 of gain, under IRC § 357(c)(1), being the excess of the liabilities assumed over the total adjusted basis of the property transferred. The transaction still qualifies under IRC § 351 — the excess is treated as gain from the sale of the property rather than disqualifying the exchange — and the corporation’s basis under IRC § 362(a) is the carryover basis increased by the gain recognised. No cash changed hands and there was no boot.

3. A partnership distributes property contributed six years earlier to a partner other than the contributor. What happens?

Answer: The contributing partner is treated as recognising the gain or loss that IRC § 704(c)(1)(A) would have allocated on the variation had the property been sold at fair market value, under IRC § 704(c)(1)(B), because the distribution occurred within seven years of the contribution. Nothing has been sold and the contributor has received nothing, which is why the rule is missed. The distributee’s basis in the property and the contributor’s outside basis are adjusted to prevent the gain being counted twice.

4. A C corporation distributes land worth $600,000 with a basis of $900,000 to its shareholder. What does the corporation recognise?

Answer: Nothing. IRC § 311(a) provides that no gain or loss is recognised to a corporation on a distribution of property with respect to its stock, and § 311(b) creates an exception only for appreciated property — where fair market value exceeds adjusted basis. Here the property is depreciated, so the exception does not apply and the $300,000 loss is not recognised. The shareholder takes the property at its fair market value and is taxed under IRC § 301(c) on that amount, so the loss disappears entirely.

5. Why does the entity choice matter more for property that will be held and later distributed than for property that will be sold by the business?

Answer: Because the exit rules diverge sharply while the sale rules do not. If the business sells the property, both regimes recognise gain — one at the entity level and one allocated to the owners, but the tax is triggered by an event that produces cash. If the property is distributed to the owners instead, a corporation recognises gain under IRC § 311(b) as though it had sold at fair market value and the shareholder is taxed again under IRC § 301(c), all without any cash arising; a partnership recognises nothing under IRC § 731(a) and the property carries a basis under IRC § 732(a). The choice made at formation therefore prices a transaction that may not happen for twenty years.