A taxpayer contributes services worth $50,000 in exchange for a 20% capital interest in a new partnership. The partnership has no assets other than the cash contributed by other partners. What is the tax consequence?

Answer options:

No income recognized.

$50,000 Capital Gain.

$50,000 Ordinary Income.

Income deferred until partnership interest is sold.

How to approach this question

Services for Capital Interest = Ordinary Income (FMV of interest). Services for Profits Interest = Generally Non-taxable.

Full Answer

C.$50,000 Ordinary Income.✓ Correct

Treas. Reg. §1.721-1(b)(1). The receipt of a partnership capital interest in exchange for services is taxable as ordinary income equal to the fair market value of the interest received.

Common mistakes

Confusing capital interest with profits interest.

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