§704(c) Built-In Gain on Contributed Land
Alpha LLC is taxed as a partnership and has two equal members, Ana and Ben. When Alpha was formed, Ana contributed a parcel of investment land with an adjusted basis of $200,000 and a fair market value of $500,000. Ben contributed $500,000 cash. Alpha has no liabilities, no other assets, and no depreciation because the property is raw land. The partnership agreement allocates all items equally, except that it includes a valid §704(c) allocation using the traditional method. In 2025, Alpha sells the land for $650,000. Ana and Ben want to know how the gain is allocated, what their outside bases are after the sale, and how the result changes if the sale price is only $450,000. They also ask whether Ben can claim that the allocation is invalid because it gives Ana more than half of the gain.
1. Allocate the $650,000 sale gain and compute Ana's and Ben's outside bases after the sale.
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Alpha's total gain = $650,000 − $200,000 = $450,000. Under §704(c)(1)(A), the built-in gain on Ana's contributed land must be allocated to Ana. Built-in gain = $500,000 FMV − $200,000 basis = $300,000. The traditional method allocates the first $300,000 of tax gain to Ana. Remaining gain = $150,000, split equally: $75,000 each. Ana: $375,000; Ben: $75,000. Outside basis: Ana starts at $200,000 (substituted basis) + $375,000 = $575,000. Ben starts at $500,000 + $75,000 = $575,000. Book capital also ends at $575,000 each because the $150,000 book gain is split equally.
2. What if Alpha sells the land for $450,000 instead of $650,000?
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Total tax gain = $450,000 − $200,000 = $250,000. The built-in gain is $300,000, which exceeds total gain. Under the traditional method and the ceiling rule, all $250,000 of tax gain is allocated to Ana; Ben receives $0. Ana's outside basis = $200,000 + $250,000 = $450,000. Ben's remains $500,000. Book capital: total book gain = $450,000 − $500,000 = −$50,000; each loses $25,000, so each book capital = $475,000. This creates a book-tax disparity for Ben, which is the ceiling rule's effect; remedial allocations could cure it if the agreement provided.
3. Can Ben successfully argue that the allocation is invalid because Ana receives more than half of the tax gain?
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No. §704(c) is mandatory and overrides the equal allocation for contributed property with built-in gain. The allocation prevents Ana's precontribution appreciation from being shifted to Ben. The partnership agreement's equal book allocations and the §704(c) tax allocation are respected. Ben's economic deal is unchanged: he still has a 50% book capital interest. If the agreement lacked a §704(c) method, the default is the traditional method under the regulations, so the result is similar. Ben could negotiate a different method, such as remedial allocations, for future contributions, but he cannot invalidate the required allocation.