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Things to Consider when Bringing On A New Business Partner

Adding a new partner to a partnership involves multiple financial and legal considerations. For instance, imagine you and your current partners are preparing to bring on a new partner. Through a cash contribution to the business, this new partner will attain a one-third stake in the partnership. We can assume that your basis in the partnership is sufficient so that the decrease in your share of the partnership’s liabilities, resulting from the new partner's admission, will not reduce your basis to zero.

More to It

To avoid obstacles, it’s encouraged to plan new partnerships with care. Consider these two issues:

  1. If the partner’s interest in unrealized receivables and substantially appreciated inventory changes, then the sale of those items will be treated as a “gain”. In this instance, accounts receivables, depreciation recapture, and ordinary income items are all considered unrealized receivables. To avoid a “gain” on these items, they must be allocated to its original partners, even after the new partner is brought on.

  2. The tax code mandates that the "built-in gain or loss" on assets held by the partnership prior to the new partner’s admission must be allocated to the current partners, rather than the new partner. Generally, "built-in gain or loss" refers to the difference between the fair market value and the basis of the partnership property at the time the new partner is admitted.

To Summarize

New partners must be allocated a portion of the depreciation proportional to their share of the depreciable property, based on its current fair market value, which resultingly will decrease the amount of depreciation available to the current partners. Additionally, the built-in gain or loss on the partnership assets must be allocated to the current partners when the partnership assets are sold. The regulations in this area are complex, and the partnership may need to implement special accounting procedures to comply with the relevant requirements.

When adding a partner or making other changes, a partner’s basis in his or her interest can undergo frequent adjustment. Thus, it’s important to keep proper track of your basis because it can impact:

  • Gain or loss on the sale of your interest

  • How partnership distributions to you are taxed

  • The maximum amount of partnership loss you can deduct

Please contact us if you would like assistance with these matters or any other issues related to your partnership.


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