Part 2 Partnerships question: capital interest in a partnership in exchange for services

Part 2Partnerships

A person who receives a capital interest in a partnership in exchange for services generally:

A Has ordinary income equal to the interest's value
B Has a capital gain equal to the value of the interest
C Has income only if the services were performed for a fee
D Has no income until the partnership is liquidated

Show the answer and explanation

Answer: A. Has ordinary income equal to the interest's value

Section 721 nonrecognition covers contributions of property, not services. A partner who receives a capital interest for services has ordinary compensation income equal to the fair market value of the interest received (a profits interest may qualify for safe harbor treatment under Rev. Proc. 93-27). The partner's basis is the amount included in income. Source: Treas. Reg. 1.721-1(b)(1); IRC 83; Pub. 541 (12-2025), Contribution of Services. Tax year: 2025 (law as of 31 Dec 2025).

Common mistake

Treating services as property eligible for section 721.

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Original study material mapped to the public IRS SEE content outlines; not a real exam question.Not affiliated with or endorsed by the IRS or PSI. Verify figures and rules against current guidance before relying on them.