The business decision to add a new partner has several financial and legal repercussions. Imagine that you and your existing partners want to welcome a new partner. By contributing cash to the partnership, the new partner will gain one-third interest in it. Further, your bases in your partnership interests are enough to prevent your bases from a reduction to zero due to the new partner’s entry. That will reduce your portions of the partnership’s liabilities.

Adding a new business partner

Even though adding a new partner may seem straightforward, careful planning is necessary to prevent potential tax issues. Here are two things to think about:

First, any change in the partners’ interests in unrealized receivables and significantly appreciated inventory is viewed as a sale of those assets. That would then result in a gain for the present partners. Unrealized receivables for this purpose also comprise other ordinary income items and depreciation recapture in addition to accounts receivable. Therefore, the current partners must receive distribution even after the new partner’s arrival to prevent recognition of those things.

Second, the “built-in gain or loss” on assets the partnership had before the new member’s admission must go to the present partners rather than the new partner. With the entry of a new partner, the difference between the basis and fair market value of the partnership’s assets is “built-in gain or loss.”

Consider the tax implications

The main consequences of these regulations include:

• The new partner shall be entitled to an amount of depreciation equal to his share of the depreciable property based on the fair market value in effect on the date of the allocation to the new partner. The present partners will be able to take less depreciation as a result.
• When partnership assets sell, the built-in gain or loss on those assets the present partners must receive the distributions. The regulations that apply here are intricate. The partnership may need to use unique accounting practices to satisfy the necessary conditions.

A partner’s reason for their interest may frequently change when adding a partner or making other modifications. Therefore, it’s crucial to keep accurate records of your basis, which affect:

• The amount of gain or loss you realize when selling your stake
• The tax on partnership payments
• How much of a loss from a partnership you can deduct

Contact our RRBB accountants and advisors for assistance with these or any other problems that might develop during your partnership.