Tax Consequences of Transferring Stock to a Newly Formed Partnership

by Jeff Franco, studioD

When you create a joint venture with at least one other person or entity, the IRS treats the venture as a partnership. Therefore, as a partner, you are also subject to the partnership income tax rules. Unless the newly formed partnership is an investment company, your contribution of stock to the new partnership is not a taxable event. However, there are other tax consequences you will face.

Tax-free Stock Contribution

At the time you transfer shares to the new partnership, there is no income tax that you or the partnership must pay on the transfer. This is true regardless of the stock’s value at the time of transfer. To illustrate, assume you purchased 100 shares in a corporation for $10,000, and when you contributed the shares to the new partnership, the value increased to $15,000. In this case, it's not necessary to recognize the $5,000 gain on your tax return. However, this also applies to the losses, meaning you cannot offset other gains on your personal tax return after transferring the shares.

Basis in Partnership

All partners, whether contributing stock to a newly formed partnership or an existing one, have a tax basis in their partnership interest. Your tax basis in the partnership represents your total personal investment in the venture. However, because the IRS allows you to avoid paying tax on the inherent gain in stocks you transfer, your basis in the partnership is the same as your basis in the stocks. Therefore, although your shares are worth $15,000 at the time of transfer, the tax basis in your partnership interest is only $10,000. This defers the gain until you sell your partnership interest. If you also contribute other property or money to the partnership, you increase your basis in the partnership by the basis of the additional property, and the amount of liabilities you assume.

Investment Company Implications

The IRS treats new partnerships as an investment company if more than 80 percent of the value of all partnership assets relate to marketable securities held for investment purposes. If you contribute stock to an investment company, you can't take advantage of the tax-free contribution rules. Therefore, you must recognize the $5,000 of gain on your personal tax return covering the year of the stock transfer. However, your basis in the partnership includes any gains you recognize, and as a result, your tax basis is $15,000 rather than $10,000.

Reporting Partnership Income

The transfer of stock in exchange for a partnership interest will affect your personal income tax return for as long as you retain the interest. Because the partnership doesn't pay income tax on its earnings, each partner must report their respective share of partnership income and deductions each year. As a result, you will receive an annual Schedule K-1 form from the partnership. This reports the amounts you must report on a Schedule E attachment to your tax return.

About the Author

Jeff Franco's professional writing career began in 2010. With expertise in federal taxation, law and accounting, he has published articles in various online publications. Franco holds a Master of Business Administration in accounting and a Master of Science in taxation from Fordham University. He also holds a Juris Doctor from Brooklyn Law School.

Photo Credits

  • Stockbyte/Stockbyte/Getty Images