Advanced Tax Strategies for LLCs and Partnerships

Chapter 2Allocations With Respect to Contributed Property: Section 704(c)(1)(A)

Learning objectives

• Distinguish between “book” allocations required under Section 704(b) and “tax” allocations required under Section 704(c).
• Identify the potential tax consequences when a partner or LLC member makes a contribution of appreciated or depreciated property to the entity.
• Distinguish between the various methods prescribed by the regulations to make required special allocations with respect to contributed property.
• Recognize the three methods described in the Section 704(c) regulations to make special allocations with respect to contributed property.

Introduction

26 CFR Section 704(b), requiring allocations to have substantial economic effect, has as its primary purpose the prevention of tax avoidance by the use of economically meaningless allocations of partnership or LLC income or loss. Partners and LLC members can reduce their tax liabilities by use of special partnership allocations, but only if those allocations are associated with real economic costs. Section 704(c), on the other hand, requires special allocations that do not cause the partner to suffer nontax economic costs, in order to prevent the use of partnerships and LLCs as tax avoidance vehicles.

Example 2-1

A contributes land to AB, Ltd., a limited liability company opting to be taxed as a partnership for federal ...