What to Know About Taxes when Adding a New Partner

In a partnership, adding a new partner has a number of financial and legal implications. Let’s imagine you and your partners want to add a new partner to the mix. By making a cash contribution, the new partner will have a one-third interest in the partnership. Assume that your partnership interests have adequate bases so that the decrease in your percentage of the partnership’s liabilities as a result of the new partner’s admission does not lower your bases to zero.

Gains and Losses

Although it may seem like a straightforward process, it is vital to plan the new person’s entrance effectively in order to prevent numerous tax issues. Here are two points to think about:

First, if the partners’ stakes in unrealized receivables and substantially appreciated inventory items change, the change is treated as a sale of those items, resulting in a gain recognized by the current partners. Unrealized receivables include not just accounts receivable, but also depreciation recapture and other ordinary income items. In order to prevent gaining recognition on certain items, they must be allocated to current partners even after the new partner’s admission.

Second, the tax code mandates that the “built-in gain or loss” on assets owned by the partnership prior to the admission of the new partner be allocated to the current partners rather than the entering partner. The difference between the fair market value and basis of the partnership property at the time the new partner is accepted is known as “built-in gain or loss.”

Assigning Depreciation

The most notable result of these regulations is that the new partner must be assigned a portion of the depreciation based on his share of the depreciable property’s existing fair market value. This will reduce the amount of depreciation that can be taken by the current partners. The second effect is that when partnership assets are sold, the built-in gain or loss on the assets must be shared to the present partners. The standards are complicated, and the partnership may need to implement special accounting processes to meet the requirements.

Basis can Vary

A partner’s basis in his or her interest might vary often when adding a partner or making other adjustments. It’s important to keep track of your basis since it affects a number of things, including the gain or loss on the sale of your interest, how partnership distributions to you are taxed, and the amount of partnership loss you may deduct.

If you need assistance with these or any other difficulties that may emerge as a result of your partnership, please contact us.

© 2022