Contributing Property to a Partnership Is Usually Tax-Free. What If You Contribute Services?
Property contributions and service contributions do not receive the same default tax treatment.
Property contribution
A partner generally does not recognize gain or loss merely for contributing property to a partnership in exchange for a partnership interest, subject to exceptions.
Services exception
Services are not property for Section 721 purposes, so receiving an interest for services can create current income.
Capital vs profits interest
The tax result can differ depending on whether the service provider receives a capital interest or a qualifying profits interest under applicable guidance.
Basis
Contributed property and recognized income affect the partner's outside basis and the partnership's inside basis under separate rules.
The takeaway
Section 721 generally protects qualifying property contributions, while receiving a partnership capital interest for services can create taxable compensation.
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FAQ
Are services treated as property under Section 721?
No.
Can a capital interest received for services be taxable?
Yes.
Do basis consequences still matter after formation?
Yes.