How does a partner's share of partnership liabilities affect outside basis?

An increase in the partner's share of liabilities is treated as a cash contribution that increases basis

An increase in the partner's share of liabilities reduces basis, like a distribution of money to the partner

Only recourse liabilities affect basis

Bill contributes a building (basis $50,000, FMV $120,000) subject to a $80,000 mortgage to a new partnership for a 25% interest. The partnership assumes the mortgage. What is Bill's outside basis?

$0, with $10,000 of gain recognized

Which item decreases a partner's outside basis?

The partner's distributive share of partnership losses

The partner's share of tax-exempt income

An increase in the partner's share of partnership liabilities

The partner's share of taxable income

A partner with an outside basis of $12,000 receives a current cash distribution of $15,000. What is the result?

$3,000 gain and basis reduced to zero

No gain; basis becomes negative $3,000

In a liquidating distribution, when can a partner recognize a loss?

Only when the partner receives nothing but money, unrealized receivables and inventory, and their basis is less than outside basis

Only if the partnership is terminated by sale

Whenever the total fair market value of the property received in the distribution, including any money, is less than the partner's outside basis

How do guaranteed payments to a partner for services affect the partner?

They are ordinary income to the partner and generally subject to self-employment tax

They reduce the partner's outside basis like a distribution and are not taxed to the partner

They are tax-free returns of capital

A partner receives a capital interest in a partnership in exchange for services. What is the tax result to the partner?

Ordinary income equal to the FMV of the capital interest received

No income until the partner later sells or liquidates the capital interest

How does a partner's share of partnership tax-exempt income affect outside basis?

It increases basis only if distributed

Partnership basis (outside and inside)

A partner's outside basis starts with cash plus the adjusted basis of contributed property, rises with income and the partner's share of partnership liabilities, falls with distributions, losses and liability relief, and cannot go below zero; a deemed distribution in excess of basis is gain.

Updated 2026-09-23 · 3 sources · By the EnrolledAgentKit team

Exam part

Part 2

Businesses

IRS domain

Business Entities and Considerations

30 of 85 scored Qs

Tax year tested

2025

2026-27 SEE

Practice questions

10 free below

The rules the exam tests

Figures for tax year 2025, the year the 2026-27 SEE tests. Verify against the cited primary source.
Rule	What it says (2025)	Source
Initial basis	Cash + adjusted basis of property contributed (+ gain recognized)	IRC 722
Liabilities	Increase in share = cash contribution; decrease = cash distribution	IRC 752
Increases	Share of taxable and tax-exempt income	IRC 705(a)(1)
Decreases	Distributions, share of losses and nondeductible expenses	IRC 705(a)(2)
Current cash distribution > basis	Gain (generally capital)	IRC 731(a)
Property distribution basis	Lesser of partnership basis or partner's outside basis	IRC 732(a)
Liquidating loss	Only if receiving just cash, receivables and inventory	IRC 731(a)(2)
Loss limit	Basis, then at-risk, passive and excess business loss rules	IRC 704(d)
Partnership's (inside) basis in contributed property	Carryover from partner	IRC 723

Worked example

Facts: Bill contributes a building (basis $50,000, FMV $120,000) subject to an $80,000 mortgage for a 25% interest; the partnership assumes the mortgage.

Outside basis: $50,000 - $80,000 relieved + 25% x $80,000 = -$10,000, so basis is $0 and Bill recognizes $10,000 gain under IRC 731. The partnership’s inside basis in the building is $50,000.

Exam traps

Liability relief is a deemed cash distribution.
Guaranteed payments are ordinary income and SE income; they are not distributions.
A capital interest received for services is ordinary income at FMV.
Section 754 adjusts inside basis; it does not change outside basis.