The formation of a partnership is generally a nonrecognition transaction for both the contributing partner and the newly created firm.[1] Thus, no gain is recognized to a partnership or to any of its partners because of a contribution of property to the partnership in exchange for an interest in the partnership.[2] While this nonrecognition rule is a useful instrument in the tax practitioner’s toolbox, the rule’s glamor often overshadows an important exception. Under I.R.C. § 721(b), the general nonrecognition rule will not apply to gain realized on a transfer of property to a partnership that would be treated as an investment company (within the meaning of I.R.C. § 351) if the partnership were incorporated.[3]
This reference to I.R.C. § 351 shifts the analysis to the transfer rules for corporations to determine if the transferee partnership qualifies as an investment company (i.e., an investment partnership). Under the Treasury Regulations, a transfer of property to an investment partnership occurs when:
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