[Code of Federal Regulations]
[Title 26, Volume 8]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.707-1]

[Page 468-470]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
Determination of Tax Liability--Table of Contents
 
Sec. 1.707-1  Transactions between partner and partnership.

    (a) Partner not acting in capacity as partner. A partner who engages 
in a transaction with a partnership other than in his capacity as a 
partner shall be treated as if he were not a member of the partnership 
with respect to such transaction. Such transactions include, for 
example, loans of money or property by the partnership to the partner or 
by the partner to the partnership, the sale of property by the partner 
to the partnership, the purchase of property by the partner from the 
partnership, and the rendering of services by the partnership to the 
partner or by the partner to the partnership. Where a partner retains 
the ownership of property but allows the partnership to use such 
separately owned property for partnership purposes (for example, to

[[Page 469]]

obtain credit or to secure firm creditors by guaranty, pledge, or other 
agreement) the transaction is treated as one between a partnership and a 
partner not acting in his capacity as a partner. However, transfers of 
money or property by a partner to a partnership as contributions, or 
transfers of money or property by a partnership to a partner as 
distributions, are not transactions included within the provisions of 
this section. In all cases, the substance of the transaction will govern 
rather than its form. See paragraph(c)(3) of Sec. 1.731-1.
    (b) Certain sales or exchanges of property with respect to 
controlled partnerships--(1) Losses disallowed. (i) No deduction shall 
be allowed for a loss on a sale or exchange of property (other than an 
interest in the partnership, directly or indirectly, between a 
partnership and a partner who owns, directly or indirectly, more than 50 
percent of the capital interest or profits interest in such partnership. 
A loss on a sale or exchange of property, directly or indirectly, 
between two partnerships in which the same persons own, directly or 
indirectly, more than 50 percent of the capital interest or profits 
interest in each partnership shall not be allowed.
    (ii) If a gain is realized upon the subsequent sale or exchange by a 
transferee of property with respect to which a loss was disallowed under 
the provisions of subdivision (i) of this subparagraph, section 267(d) 
(relating to amount of gain where loss previously disallowed) shall 
apply as though the loss were disallowed under section 267(a)(1).
    (2) Gains treated as ordinary income. Any gain recognized upon the 
sale or exchange, directly or indirectly, of property which, in the 
hands of the transferee immediately after the transfer, is property 
other than a capital asset, as defined in section 1221, shall be 
ordinary income if the transaction is between a partnership and a 
partner who owns, directly or indirectly, more than 80 percent of the 
capital interest or profits interest in the partnership. This rule also 
applies where such a transaction is between partnerships in which the 
same persons own, directly or indirectly, more than 80 percent of the 
capital interest or profits interest in each partnership. The term 
property other than a capital asset includes (but is not limited to) 
trade accounts receivable, inventory, stock in trade, and depreciable or 
real property used in the trade or business.
    (3) Ownership of a capital or profits interest. In determining the 
extent of the ownership by a partner, as defined in section 761(b), of 
his capital interest or profits interest in a partnership, the rules for 
constructive ownership of stock provided in section 267(c) (1), (2), 
(4), and (5) shall be applied for the purpose of section 707(b) and this 
paragraph. Under these rules, ownership of a capital or profits interest 
in a partnership may be attributed to a person who is not a partner as 
defined in section 761(b) in order that another partner may be 
considered the constructive owner of such interest under section 267(c). 
However, section 707(b)(1)(A) does not apply to a constructive owner of 
a partnership interest since he is not a partner as defined in section 
761(b). For example, where trust T is a partner in the partnership ABT, 
and AW, A's wife, is the sole beneficiary of the trust, the ownership of 
a capital and profits interest in the partnership by T will be 
attributed to AW only for the purpose of further attributing the 
ownership of such interest to A. See section 267(c) (1) and (5). If A, 
B, and T are equal partners, then A will be considered as owning more 
than 50 percent of the capital and profits interest in the partnership, 
and losses on transactions between him and the partnership will be 
disallowed by section 707(b)(1)(A). However, a loss sustained by AW on a 
sale or exchange of property with the partnership would not be 
disallowed by section 707, but will be disallowed to the extent provided 
in paragraph (b) of Sec. 1.267(b)-1. See section 267 (a) and (b), and 
the regulations thereunder.
    (c) Guaranteed payments. Payments made by a partnership to a partner 
for services or for the use of capital are considered as made to a 
person who is not a partner, to the extent such payments are determined 
without regard to the income of the partnership. However, a partner must 
include such payments as ordinary income for his taxable year within or 
with which ends

[[Page 470]]

the partnership taxable year in which the partnership deducted such 
payments as paid or accrued under its method of accounting. See section 
706(a) and paragraph (a) of Sec. 1.706-1. Guaranteed payments are 
considered as made to one who is not a member of the partnership only 
for the purposes of section 61(a) (relating to gross income) and section 
162(a) (relating to trade or business expenses). For a guaranteed 
payment to be a partnership deduction, it must meet the same tests under 
section 162(a) as it would if the payment had been made to a person who 
is not a member of the partnership, and the rules of section 263 
(relating to capital expenditures) must be taken into account. This rule 
does not affect the deductibility to the partnership of a payment 
described in section 736(a)(2) to a retiring partner or to a deceased 
partner's successor in interest. Guaranteed payments do not constitute 
an interest in partnership profits for purposes of sections 706(b)(3), 
707(b), and 708(b). For the purposes of other provisions of the internal 
revenue laws, guaranteed payments are regarded as a partner's 
distributive share of ordinary income. Thus, a partner who receives 
guaranteed payments for a period during which he is absent from work 
because of personal injuries or sickness is not entitled to exclude such 
payments from his gross income under section 105(d). Similarly, a 
partner who receives guaranteed payments is not regarded as an employee 
of the partnership for the purposes of withholding of tax at source, 
deferred compensation plans, etc. The provisions of this paragraph may 
be illustrated by the following examples:

    Example 1. Under the ABC partnership agreement, partner A is 
entitled to a fixed annual payment of $10,000 for services, without 
regard to the income of the partnership. His distributive share is 10 
percent. After deducting the guaranteed payment, the partnership has 
$50,000 ordinary income. A must include $15,000 as ordinary income for 
his taxable year within or with which the partnership taxable year ends 
($10,000 guaranteed payment plus $5,000 distributive share).
    Example 2. Partner C in the CD partnership is to receive 30 percent 
of partnership income as determined before taking into account any 
guaranteed payments, but not less than $10,000. The income of the 
partnership is $60,000, and C is entitled to $18,000 (30 percent of 
$60,000) as his distributive share. No part of this amount is a 
guaranteed payment. However, if the partnership had income of $20,000 
instead of $60,000, $6,000 (30 percent of $20,000) would be partner C's 
distributive share, and the remaining $4,000 payable to C would be a 
guaranteed payment.
    Example 3. Partner X in the XY partnership is to receive a payment 
of $10,000 for services, plus 30 percent of the taxable income or loss 
of the partnership. After deducting the payment of $10,000 to partner X, 
the XY partnership has a loss of $9,000. Of this amount, $2,700 (30 
percent of the loss) is X's distributive share of partnership loss and, 
subject to section 704(d), is to be taken into account by him in his 
return. In addition, he must report as ordinary income the guaranteed 
payment of $10,000 made to him by the partnership.
    Example 4. Assume the same facts as in example 3 of this paragraph, 
except that, instead of a $9,000 loss, the partnership has $30,000 in 
capital gains and no other items of income or deduction except the 
$10,000 paid X as a guaranteed payment. Since the items of partnership 
income or loss must be segregated under section 702(a), the partnership 
has a $10,000 ordinary loss and $30,000 in capital gains. X's 30 percent 
distributive shares of these amounts are $3,000 ordinary loss and $9,000 
capital gain. In addition, X has received a $10,000 guaranteed payment 
which is ordinary income to him.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7891, 48 FR 
20049, May 4, 1983]