Taxterity research

Disguised sale issue spotting for partner contributions and distributions

Reviewed 2026-09-15 · AI-assisted draft and editing; sources and limitations remain visible for independent review.

Answer: A contribution of property to a partnership paired with a transfer of money back to the same partner can be recharacterized as a sale, and a two-year clock decides which side carries the burden. Section 707(a)(2)(B) treats the two transfers as a sale or exchange of property where, viewed together, they are properly characterized that way. The regulation makes that concrete: a sale exists only if, on all the facts and circumstances, the transfer of money or other consideration would not have been made but for the transfer of property and, where the transfers are not simultaneous, the later transfer is not dependent on the entrepreneurial risks of partnership operations, with ten listed factors tending to prove a sale. Transfers within a two-year period are presumed to be a sale unless the facts clearly establish otherwise, and transfers more than two years apart are presumed not to be a sale on the same clearly-establish standard, so the direction of the presumption, not the underlying test, is usually what the calendar changes. Liabilities are the trap. A partnership that assumes or takes property subject to a liability is treated as transferring consideration to the extent the liability exceeds the partner's share of it, unless the liability is qualified, and a transfer funded by partnership borrowing within 90 days counts only above the partner's allocable share of that borrowing. Mirror rules apply to property moving from the partnership to a partner. Where a non-simultaneous pair is reported as something other than a sale, the regulation requires disclosure. One currency point belongs in every file opened now: Pub. L. 119-21 amended the opening words of section 707(a)(2) on July 4, 2025, so the paragraph reads "Except as provided by the Secretary" rather than "Under regulations prescribed by the Secretary", effective for services performed and property transferred after that date.

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Scope

Jurisdiction: United States — federal

Tax periods: Not period-specific; checked 2026-09-15, Property transferred after 2025-07-04, eCFR text as of 2026-09-14

Assumptions

Exclusions

1. What the statute recharacterizes

Section 707(a)(1) starts from the proposition that a partner dealing with the partnership other than in the capacity of a member is treated as a non-partner. Section 707(a)(2)(B) then reaches a case the parties have styled as a contribution and a distribution. Where there is a direct or indirect transfer of money or other property by a partner to a partnership, a related direct or indirect transfer by the partnership to that partner or to another partner, and the transfers viewed together are properly characterized as a sale or exchange of property, the transfers are treated either as a section 707(a)(1) transaction or as one between partners acting other than as members.

The regulation adds the piece the statute leaves open: when the sale is treated as occurring. It happens on the date the partnership is considered the owner of the property under general tax principles, and if the partnership's consideration moves later, the partnership is treated as having incurred an obligation on that date. That timing point is what drives the imputed interest and installment consequences a full analysis has to reach.

Check the vintage of the statutory text before quoting it. Pub. L. 119-21, section 70602(a), enacted July 4, 2025, replaced the opening words of section 707(a)(2). The paragraph previously began "Under regulations prescribed by the Secretary" and now begins "Except as provided by the Secretary", so the provision no longer reads as though it waits on regulations before it can operate. The amendment applies to services performed, and property transferred, after the date of enactment. Congress also added a rule of construction stating that nothing in the section or its amendments creates any inference about the proper treatment under section 707(a) of payments for services performed, or property transferred, on or before that date. For property transfers the practical effect is modest, because the regulations under section 707(a)(2)(B) were already in force; for a transaction straddling July 4, 2025, identify which text governs before relying on either.

2. The operative test

Two conditions, both drawn from all the facts and circumstances. First, the transfer of money or other consideration would not have been made but for the transfer of property. Second, where the transfers are not simultaneous, the subsequent transfer is not dependent on the entrepreneurial risks of partnership operations. A payment that genuinely rides on how the business performs is the opposite of a purchase price.

The regulation lists ten factors that tend to prove a sale. Read as a group they describe certainty: the timing and amount of the later transfer are determinable with reasonable certainty; the partner has a legally enforceable right to it; the partner's right is secured; another person is required to contribute to enable the transfer; another person lends or advances to enable it; the partnership incurs debt to enable it; the partnership holds liquid assets beyond its reasonable needs that are expected to be available; partnership distributions, allocations or control are designed to effect an exchange of the burdens and benefits of ownership; the transfer is disproportionately large in relation to the partner's continuing interest in profits; and the partner has no obligation to return or repay the money, or an obligation that arises so late that its present value is small.

Score the factors against documents, not impressions. A subscription or contribution agreement, a credit agreement, a cash flow projection and the partnership agreement's distribution waterfall are where seven of the ten live.

3. The two-year presumptions run in both directions

If within a two-year period a partner transfers property to a partnership and the partnership transfers money or other consideration to that partner, the transfers are presumed to be a sale unless the facts and circumstances clearly establish otherwise. The order of the two transfers does not matter for the presumption.

If the two transfers are more than two years apart, the presumption reverses: they are presumed not to be a sale unless the facts and circumstances clearly establish that they are. Both presumptions use the same clearly-establish standard, so the calendar changes who has to carry the argument rather than changing the substantive test.

The same framework applies in the opposite direction. Where the partnership transfers property to a partner and the partner transfers money or other consideration to the partnership, the principles of the contribution-side regulation apply, with a two-year window and its own presumption.

4. Transfers that are presumed not to be part of a sale

Three categories get their own presumptions, and they are the reason ordinary partnership economics do not become sales. A guaranteed payment for capital, meaning a payment to a partner determined without regard to partnership income and made for the use of that partner's capital, is presumed to be a guaranteed payment for capital rather than part of a sale where it is reasonable in amount, unless the facts clearly establish otherwise. An unreasonable one is presumed not to be a guaranteed payment for capital, which cuts the other way.

A reasonable preferred return, meaning a preferential distribution of partnership cash flow with respect to contributed capital that will be matched to the extent available by an allocation of income or gain, is presumed not to be part of a sale. Reasonableness for both categories has two parts. The transfer must be made under a written provision of the partnership agreement providing for payment for the use of capital in a reasonable amount, and the amount must clear a formula: the sum of any preferred return and any guaranteed payment for capital payable for the year cannot exceed the partner's unreturned capital at the start of the year, or the partner's weighted average capital balance for the year, multiplied by a safe harbor interest rate equal to 150 percent of the highest applicable federal rate in effect at any time from when the right was first established.

Operating cash flow distributions are presumed not to be part of a sale to the extent they do not exceed net cash flow from operations for the year multiplied by the lesser of the partner's percentage interest in overall partnership profits for that year or for the life of the partnership. Net cash flow from operations is a defined computation starting from taxable income or loss from the ordinary course, adjusted for non-cash charges, debt principal payments, reserves and capital expenditures.

A fourth category is an exception rather than a presumption, and it is the one most often missed on a formation. A transfer by the partnership to reimburse a partner for capital expenditures the partner incurred during the two years preceding the transfer is not treated as part of a sale, to the extent it does not exceed those expenditures, where they were incurred either on organization and syndication costs described in section 709 or with respect to the property transferred. For the property category the reimbursement cannot exceed 20 percent of the property's fair market value at the time of transfer, except that the 20 percent limitation does not apply where fair market value does not exceed 120 percent of the partner's adjusted basis in the property. Both tests run property by property, subject to a narrow aggregation rule for small properties. A related rule lets a partner step into the shoes of a person who incurred the expenditures where the property came across in a nonrecognition transaction.

One more drafting point on all three presumptions: guaranteed payments for capital, preferred returns and operating cash flow distributions presumed not to be part of a sale do not lose the benefit of the presumption merely because they are retained for distribution in a later year.

5. Liabilities are where plain contributions become sales

If the partnership assumes or takes property subject to a liability of the partner that is not a qualified liability, the partnership is treated as transferring consideration to the partner to the extent the liability exceeds the partner's share of that liability immediately after the transaction. The partner's share is determined under section 752 for a recourse liability, and for a nonrecourse liability by the same percentage used to determine the partner's share of excess nonrecourse liabilities under the third tier of the section 752 regulation.

There is a restriction that changes numbers. The significant item, alternative and additional methods available for allocating excess nonrecourse liabilities under Reg. 1.752-3(a)(3) do not apply for purposes of the disguised sale computation. A partnership that uses one of those methods for basis reporting cannot carry the same percentage into this calculation.

A liability is qualified only within defined categories: one incurred by the partner more than two years before the earlier of the written transfer agreement or the transfer, and that encumbered the property throughout that period; one incurred within the two-year window but not in anticipation of the transfer, that has encumbered the property since it was incurred; one allocable under the section 163 tracing rules to capital expenditures with respect to the property; and two ordinary-course-of-business categories that require all the assets related to that trade or business to be transferred, apart from assets immaterial to continuing it. For a recourse liability there is an added cap: the amount cannot exceed the fair market value of the transferred property, reduced for senior liabilities.

A liability incurred within two years of the transfer, or of a written agreement to transfer, is presumed to have been incurred in anticipation of it. That presumption is rebuttable, and rebutting it triggers the disclosure rule below.

6. The debt-financed distribution exception

Where a partner transfers property to a partnership and the partnership then incurs a liability, and the proceeds of that liability are allocable under the section 163 tracing rules to a transfer of money or other consideration made to that partner within 90 days of incurring it, the transfer to the partner is taken into account only to the extent it exceeds the partner's allocable share of the liability.

The allocable share is a fraction, not the whole liability share. It equals the partner's share of the liability multiplied by the portion of the liability allocable to the money transferred, divided by the total amount of the liability. Where the partnership makes debt-financed transfers to more than one partner under a plan, the liabilities incurred under the plan are treated as one liability for this purpose.

Two practical consequences. The 90-day window is measured from incurring the liability, so a borrowing that precedes the transfer by more than 90 days does not fit the exception. And because the computation depends on the partner's section 752 share, an error in the liability allocation flows straight into a disguised sale conclusion.

7. Fact intake, then disclosure

Collect the dates first: the date of the written transfer agreement, the date the partnership became the owner, every transfer of money or other consideration in either direction, and the date each liability was incurred. Then the documents behind the ten factors, the partnership agreement's distribution and allocation provisions, the credit agreement, and the cash flow projection relied on at the time. Then the liability detail, encumbrance history, use of proceeds, and the partner's share of each liability before and after the transaction. Then the capital expenditure records for the two years before the transfer, with the invoices and the fair market value and adjusted basis figures the 20 percent and 120 percent tests need. Then the payment history for anything characterized as a guaranteed payment for capital or a preferred return, with the written partnership agreement provision relied on, the applicable federal rate used, and the unreturned capital or weighted average capital balance figures. Finally, an explicit statement of which presumption applies on these dates and what evidence is meant to overcome it.

Disclosure is an affirmative obligation, not a defensive option. Where a partner transfers property and the partnership transfers money or other consideration within two years, the partner treats them as other than a sale, and the transfer is not within the presumed-safe categories of payments for capital, reasonable preferred returns or operating cash flow distributions, the regulation requires disclosure. It is made on a completed Form 8275 or on a statement attached to the transferor's return for the year of the transfer, captioned as a section 707 disclosure, identifying the item or group of items, stating the amount of each, and setting out the facts affecting the potential treatment. The same disclosure mechanism covers a liability incurred within two years of the transfer and the partnership-to-partner analogue, and where several partners transfer property under a plan the partnership may make the disclosure on their behalf.

The liability share this analysis consumes is derived in a companion page in this library, Allocating partnership liabilities under section 752; this page takes that share as an input and works out what it does inside section 707.

When the dates and documents are assembled, ask Taxterity a research question on the specific transfer pair, or run a Federal Tax Memo covering the characterization and the disclosure position, then verify each cited authority against the documents before the return is filed.

Related research

Official sources

  1. 26 U.S.C. 707 — Transactions between partner and partnership — Section 707(a)(1); 707(a)(2) introductory text as amended by Pub. L. 119-21 sec. 70602(a) (July 4, 2025); 707(a)(2)(B)(i)-(iii) and flush text; 2025 effective-date and rule-of-construction notes; as in effect 2026-09-14
  2. 26 CFR 1.707-3 — Disguised sales of property to partnership; general rules — Paragraph (a)(1)-(2), general rule and when the sale occurs; (b)(1)(i)-(ii), the but-for and entrepreneurial-risk conditions; (b)(2)(i)-(x), the ten factors
  3. 26 CFR 1.707-3 — Disguised sales of property to partnership; general rules — Paragraph (c)(1), two-year presumption of sale; (c)(2), the three conditions triggering disclosure; (d), presumption against sale for transfers more than two years apart
  4. 26 CFR 1.707-4 — Disguised sales of property to partnership; guaranteed payments, preferred returns, operating cash flow distributions, reimbursements of preformation expenditures — Paragraph (a)(1)(i)-(iii), guaranteed payment for capital; (a)(2), preferred returns; (a)(3)(i)-(ii), written provision and the 150 percent of highest applicable federal rate formula; (b)(1)-(2), operating cash flow distributions
  5. 26 CFR 1.707-4 — Disguised sales of property to partnership; guaranteed payments, preferred returns, operating cash flow distributions, reimbursements of preformation expenditures — Paragraph (c), accumulated payments keep the presumption; (d)(1)(i)-(ii), reimbursement of preformation capital expenditures, the 20 percent limitation and the 120 percent test; (d)(2), step-in-the-shoes for another person's expenditures
  6. 26 CFR 1.707-5 — Disguised sales of property to partnership; special rules relating to liabilities — Paragraph (a)(1), liability in excess of the partner's share as consideration; (a)(2)(i)-(ii), determining the share for recourse and nonrecourse liabilities
  7. 26 CFR 1.707-5 — Disguised sales of property to partnership; special rules relating to liabilities — Paragraph (a)(6)(i)(A)-(E) and (a)(6)(ii), qualified liability categories and the fair market value cap; (a)(7), anticipation presumption; (b)(1)-(2), debt-financed transfers within 90 days
  8. 26 CFR 1.707-6 — Disguised sales of property by partnership to partner; general rules — Paragraph (a), application of the 1.707-3 principles in the reverse direction; (b), liabilities and the modified qualified liability definition
  9. 26 CFR 1.707-8 — Disclosure of certain information — Paragraph (a), the three cross-referenced disclosure triggers; (b)(1)-(4), Form 8275 or attached statement and its four required contents; (c), disclosure by the partnership for multiple transferors
  10. 26 CFR 1.752-3 — Partner's share of nonrecourse liabilities — Paragraph (a)(3), excess nonrecourse liabilities and the statement that the significant item, alternative and additional methods do not apply for purposes of 1.707-5(a)(2)

Limitations