How is a Partnership Funded?

This is a very complicated topic that draws upon ones knowledge of tax law. The partners fund the partnership by contributing assets to the partnership. The value of the assets contributed to the partnership is in exchange for an ownership interest in the partnership.

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How does funding the partnership create compensation and tax issues?

If partners contribute assets of equal value and ownership of the partnership is divided equally, then there is no tax issue. If, however, one partner contributes assets of greater value and the ownership interests are equal, then the partner contributing property of a lower value is treated as having received income from the partnership. The income attributed to this partner equals 1/2 of the difference between the value of the property contributed. This is as a form of phantom income. 

A partner may have a basis (amount of money invested) in property that is higher or lower than the actual value of the property contributed to the partnership. The partner does not generally recognize any income or losses when contributing this property to the partnership. The partnership, however, takes a basis in the property equal to that of the contributing partner. 

The situation gets very tricky when the partner receives some kind of value other than an ownership interest back from the partnership. This other value is known as boot. 

The situation is further complicated if the partnership later disposes of the property. There is a significant issue as to how the profits or losses are allocated for tax purposes. The issue of taxation is discussed further in the Startup Accounting Resources text.