Partnership and LLC compliance topics covering formation, basis, allocations, guaranteed payments, and distributions.
This chapter covers the flow-through entity rules that often generate the densest TCP computations. The emphasis is on Section 721 formation, inside versus outside basis, the allocation framework under Section 704, and the distribution rules that can unexpectedly trigger gain or disguised-sale treatment.
Partnership and LLC questions should track both the entity’s property and the partner’s outside basis. The same transaction can be nonrecognition at formation, basis-shifting during operations, and gain-triggering at distribution or disguised sale.
| Partnership issue | First question | Common TCP trap |
|---|---|---|
| Section 721 formation | Is the contribution eligible for nonrecognition, and what built-in gain or loss follows the property? | Calling formation tax-free without tracking carryover consequences. |
| Inside and outside basis | Which basis is being measured and whose tax consequence is at issue? | Mixing partnership inside basis with partner outside basis. |
| Special allocations and guaranteed payments | Does the allocation have substantial economic effect, or is the payment treated separately? | Treating all partner cash receipts as distributions. |
| Distributions and disguised sales | Does the transaction distribute property, liquidate an interest, or function as a sale? | Missing gain because cash, liabilities, or related steps change the result. |
| Step | What to do | Why it matters on TCP |
|---|---|---|
| 1. Identify the transaction stage | Determine whether the fact pattern involves formation, operations, allocation, payment, distribution, liquidation, or sale-like steps. | Partnership rules change depending on where the transaction occurs in the lifecycle. |
| 2. Track inside and outside basis | Update partnership basis in assets and each partner’s outside basis separately. | TCP often tests whose basis is being measured. |
| 3. Apply allocation rules | Evaluate substantial economic effect, special allocations, guaranteed payments, and separately stated items. | Partner economics and tax reporting do not always follow simple ownership percentages. |
| 4. Analyze liabilities and cash | Consider debt allocations, cash distributions, deemed distributions, and at-risk support. | Liabilities can create or reduce basis and can trigger gain when cash exceeds outside basis. |
| 5. Check disguised-sale and liquidation issues | Look for related contribution-distribution steps, property distributions, and final basis adjustments. | Transactions that look like distributions may be treated as sales or gain-triggering events. |
| Checkpoint | Exam use | What to avoid |
|---|---|---|
| Lifecycle stage | Classify the facts as formation, operations, allocation, payment, distribution, liquidation, or sale-like steps. | Applying distribution rules to a formation or compensation fact pattern. |
| Two-level basis | Track partnership inside basis and each partner’s outside basis separately. | Mixing the entity’s asset basis with the partner’s ownership basis. |
| Allocation support | Evaluate substantial economic effect, special allocations, guaranteed payments, and separately stated items. | Treating every partner cash receipt as a distribution. |
| Liability impact | Update basis for recourse and nonrecourse debt allocations, deemed contributions, and deemed distributions. | Ignoring liability relief that can trigger gain. |
| Disguised-sale risk | Look for contribution-distribution pairs, related steps, property shifts, and liquidation adjustments. | Accepting distribution form when the substance resembles a sale. |