Reference no: EM132648095

Problem - In the "old days," one partner could contribute cash and another partner could contribute an equal value of appreciated property with no subsequent record-keeping requirements. Future depreciation deductions and gains on sale of the property could be allocated to both partners equally, thereby shifting income from one taxpayer to another. A partner in a lower tax bracket (or with expiring net operating losses and the like) could report the share of the gain on sale of the asset with a relatively low corresponding tax burden.

Section 704(c)(1)(A) was added to the Code to ensure that the partner contributing the property pays tax on any built-in gain. This prevents income shifting among taxpayers and loss of revenue to the U.S. Treasury.

There is no corresponding provision for S corporations- gains and losses and depreciation expense are allocated among the shareholders without regard to any built-in appreciation on contributed property.

Assume that a new partner or shareholder owns land valued at $100,000 in which the tax basis is $60,000. How would the "incidence of taxation" differ for the entities and owners if (1) the owner (partner or shareholder) sold the property and contributed the $100,000 proceeds versus (2) the owner (partner or shareholder) contributed that same property with the entity selling it for $100,000? What theory of partnership taxation supports this difference in treatment?