[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: 26CFR1.721-1]

[Page 499-500]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
Determination of Tax Liability--Table of Contents
 
Sec. 1.721-1  Nonrecognition of gain or loss on contribution.

    (a) No gain or loss shall be recognized either to the partnership or 
to any of its partners upon a contribution of property, including 
installment obligations, to the partnership in exchange for a 
partnership interest. This rule applies whether the contribution is made 
to a partnership in the process of formation or to a partnership which 
is already formed and operating. Section 721 shall not apply to a 
transaction between a partnership and a partner not acting in his 
capacity as a partner since such a transaction is governed by section 
707. Rather than contributing property to a partnership, a partner may 
sell property to the partnership or may retain the ownership of property 
and allow the partnership to use it. In all cases, the substance of the 
transaction will govern, rather than its form. See paragraph (c)(3) of 
Sec. 1.731-1. Thus, if the transfer of property by the partner to the 
partnership results in the receipt by the partner of money or other 
consideration, including a promissory obligation fixed in amount and 
time for payment, the transaction will be treated as a sale or exchange 
under section 707 rather than as a contribution under section 721. For 
the rules governing the treatment of liabilities to which contributed 
property is subject, see section 752 and Sec. 1.752-1.
    (b)(1) Normally, under local law, each partner is entitled to be 
repaid his contributions of money or other property to the partnership 
(at the value placed upon such property by the partnership

[[Page 500]]

at the time of the contribution) whether made at the formation of the 
partnership or subsequent thereto. To the extent that any of the 
partners gives up any part of his right to be repaid his contributions 
(as distinguished from a share in partnership profits) in favor of 
another partner as compensation for services (or in satisfaction of an 
obligation), section 721 does not apply. The value of an interest in 
such partnership capital so transferred to a partner as compensation for 
services constitutes income to the partner under section 61. The amount 
of such income is the fair market value of the interest in capital so 
transferred, either at the time the transfer is made for past services, 
or at the time the services have been rendered where the transfer is 
conditioned on the completion of the transferee's future services. The 
time when such income is realized depends on all the facts and 
circumstances, including any substantial restrictions or conditions on 
the compensated partner's right to withdraw or otherwise dispose of such 
interest. To the extent that an interest in capital representing 
compensation for services rendered by the decedent prior to his death is 
transferred after his death to the decedent's successor in interest, the 
fair market value of such interest is income in respect of a decedent 
under section 691.
    (2) To the extent that the value of such interest is: (i) 
Compensation for services rendered to the partnership, it is a 
guaranteed payment for services under section 707(c); (ii) compensation 
for services rendered to a partner, it is not deductible by the 
partnership, but is deductible only by such partner to the extent 
allowable under this chapter.
    (c) Underwritings of partnership interests--(1) In general. For the 
purpose of section 721, if a person acquires a partnership interest from 
an underwriter in exchange for cash in a qualified underwriting 
transaction, the person who acquires the partnership interest is treated 
as transferring cash directly to the partnership in exchange for the 
partnership interest and the underwriter is disregarded. A qualified 
underwriting transaction is a transaction in which a partnership issues 
partnership interests for cash in an underwriting in which either the 
underwriter is an agent of the partnership or the underwriter's 
ownership of the partnership interests is transitory.
    (2) Effective date. This paragraph (c) is effective for qualified 
underwriting transactions occurring on or after May 1, 1996.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8665, 61 FR 19189, May 1, 1996]