Rental w/ deprec & debt transferred to existing partnership

[Terry D EA]

Client has four rental properties that have been claimed on Sch E. Transferred the properties into an already established LLC that is a partnership. Deeds and mortgages all transferred legally. For depreciation purposes, is the LLC basis for depreciation the contributing partner's remaining basis? All of the income, expenses, etc. are split between the personal return and the 1065 based on the date of transfer for the partner who is contributing the properties. I know this affects his basis in the partnership as well. I'm just drawing a mind blank right now on the depreciation issue. Thinking through this, if the LLC could step up the basis, wouldn't that mean a taxable gain to the partner contributing the property?

[Pacun]

No, no step up basis because no one has died.  The basis for the partnership is adjusted basis or FMV at the time of the transfer.

[Terry D EA]

I agree with no step up in basis. Maybe the words "step up" were used in the wrong context. Here is what I found so far which answers the majority of my question

26 U.S. Code § 723.Basis of property contributed to partnership

U.S. Code

The basis of property contributed to a partnership by a partner shall be the adjusted basis of such property to the contributing partner at the time of the contribution increased by the amount (if any) of gain recognized under section 721(b) to the contributing partner at such time.

721(b) is relating to intangibles, not applicable in this case.

The only way I see the partner(s) will realize any taxable gain on the transfers is if any of the contributed properties are sold. I am sure, in this case, the other partner is aware of this.

[Terry D EA]

Here is an excellent article regarding transfer of partnership interest. I know some folks here don't like clicking on links but this is too much to copy and paste.

Transfer of Partnership Interest, Tax, Sales, Disguised sales and terminations

[jklcpa]

Wow, where to start with this one!

Yes, the partnership depreciation should continue on using the same method and remaining life that the contributing partner used. It doesn't start over, so you would be entering cost and accumulated depreciation. If the contribution wasn't on the first day of the tax year, be sure that the partial year depreciation expenses on the (former) Sch E and on the partnership return are calculated correctly.

Sec 721 overall says that, in general, partner receives nonrecognition of gain/loss on contribution to a partnership.  Sec 721(b) deals with contributions to investment companies, not intangibles, but still doesn't apply here.

Contributing partner MAY have gain recognition if he is relieved of debt to the extent that the debt exceeds his basis in the property contributed.  Any debt relief to the contributing partner is considered a deemed distribution that will reduce his basis in the partnership, and if that deemed distribution exceeds his partnership basis, that then creates a gain that the contributing partner will recognize.  If that happens, iirc, then the partnership gets a step-up in basis.  So, yes, sometimes a partnership can have a step-up when no one died, and yes, "step-up" is the correct term.

You will have special allocations in the partnership that are meant to keep the contributing partner from shifting tax attributes (the built-in gain from contributing appreciated property) to the other partners. 

 Maybe someone else can explain this more clearly. Below are a couple of links that describe some of these problems are their handling more fully, including examples and code references.   (Give me a few minutes to get to my desktop - can't post the links from my tablet right now for some reason.)

 

[jklcpa]

Here is some reading for you. Note, these do go to pdfs:

Contribution Of Appreciated Property To A Partnership: More Than Just A Nice Credit To The Capital Account

and this one has a couple of basic examples of the debt problem:

Structuring Contributions of Appreciated Property to Partnerships: Avoiding Tax Recognition on Built-in Gain Assets

 

[Terry D EA]

Judy,

Thanks so much for the info. I will review the links in your last message. I just learned from the partner that he did not transfer four properties but only transferred two into the partnership. The reason the transfer of the remaining two properties did not take place, they are mortgaged and the bank wouldn't allow it. So all properties this partner has moved were paid for so no worries on the affect on the basis or gain recognition. 

The same partner has created an additional LLC for asset protection as recommended by his attorney. Those properties are also clear. Even though this LLC is a disregarded entity, I will still track his basis in the LLC.