A owns property with a fair market value of 10,000 and an adjusted tax basis of 4,000 that is subject to a mortgage of 6,000. A contributes that property to a partnership in exchange for a 20 percent interest; the existing partners hold the remaining 80 percent. The net value transferred is 4,000 — the 10,000 fair market value less the 6,000 mortgage assumed by the partnership.
Under section 722, A’s basis in the partnership interest starts with the 4,000 adjusted basis of the contributed property. When a partnership assumes a liability of a contributing partner, section 752(b) treats the portion of that liability shifted to the other partners as a deemed distribution of money to the contributing partner. Here the other partners bear 80 percent of the 6,000 mortgage — 4,800 — which is treated as a distribution to A.
Reducing A’s 4,000 starting basis by the 4,800 deemed distribution would produce a negative basis. Because basis cannot fall below zero, A’s outside basis is fixed at zero and, under section 731(a)(1), the 800 of deemed distribution in excess of basis is recognized as gain. The result is a basis of zero in A’s 20 percent interest and 800 of recognized gain.
A contributes property worth 10,000 subject to a 6,000 mortgage, so the net value transferred to the partnership is 4,000 in exchange for a 20 percent interest.
Under section 752(b), the 80 percent of the 6,000 mortgage assumed by the other partners — 4,800 — is treated as a distribution of money to A that reduces A’s basis in the partnership interest.
A’s starting basis of 4,000 is reduced by the 4,800 deemed distribution, but because outside basis cannot be negative it is fixed at zero.
The 800 by which the deemed distribution exceeds A’s 4,000 basis is recognized as gain under section 731(a)(1), leaving A with a zero-basis 20 percent interest.
