Tax-free contribution of already-diversified securities portfolios to an investment-company partnership under 721
Plain-English summary
When someone contributes property to a partnership in exchange for a partnership interest, section 721 usually lets them do it without paying tax on any built-in gain. There is an exception in section 721(b): if the partnership would count as an "investment company," the contribution can be taxed, because pooling different investors' assets can "diversify" their holdings, and the law treats that diversification like a taxable swap. Here, X is an LLC taxed as a partnership, and four trusts plus two individuals planned to contribute cash and portfolios of stocks and securities to it. X conceded that, if it were a corporation, it would be an investment company. So the real question was whether the contributions would cause diversification. Because each contributor was putting in an already-diversified portfolio (one that meets the 25 percent and 50 percent tests of section 368(a)(2)(F)(ii)), plus only a small slice of cash, the transfers did not result in diversification. The IRS ruled that the partners recognize no gain under section 721 on their contributions. The ruling binds only this taxpayer.
Ruling snapshot
- Question: Will partners recognize gain under section 721 when they contribute cash and diversified securities portfolios to a partnership that would qualify as an investment company?
- Outcome: approved (no gain recognized)
- Key authorities: IRC §§ 721, 351(e)(1), 368(a)(2)(F)(ii); Treas. Reg. § 1.351-1(c)
Full text (IRS public release)
Internal Revenue Service Department of the Treasury
Washington, DC 20224
Number: 202622001 Third Party Communication: None
Release Date: 5/29/2026 Date of Communication: Not Applicable
Index Number: 721.00-00
Person To Contact:
--------------------------------------------- ----------------------, ID No. -----------------
--------------------------------------------------------- Telephone Number:
--------------------------------------- --------------------
--------------------------- Refer Reply To:
------------------------------------ CC:PT&E:B03
PLR-113817-25
Date:
February 17, 2026
Legend
X = ---------------------------------------------
------------------------
Trust 1 = --------------------------------------------------
------------------------
Trust 2 = ---------------------------------------------------------
------------------------
Trust 3 = -----------------------------------------------
------------------------
Trust 4 = -----------------------------------------------
------------------------
A = -------------------
---------------------------
B = -------------------
---------------------------
State = -----------
Date = --------------------------
n = --
PLR-113817-25 2
Dear -----------------:
This letter responds to a letter dated February 28, 2025 and additional
correspondence, submitted on behalf of X by X’s authorized representative, requesting
a ruling under § 721 of the Internal Revenue Code (Code) that certain taxpayers will not
recognize gain or loss on proposed contributions of assets to X.
FACTS
According to the information submitted and representations made X was
organized as a limited liability company on Date under the laws of State. Effective Date,
X elected to be taxed as a partnership for federal tax purposes. Trust 1, Trust 2, Trust 3,
Trust 4, and individuals A and B (the “Partners”) intend to enter into a transaction in
which the Partners will contribute cash and certain specifically identified investment
assets to X (proposed transaction).
X represents that immediately after the receipt of cash and investment assets in
the proposed transaction, X would, were it incorporated, qualify as an investment
company for purposes of § 351(e)(1). X also represents that the investment assets that
would be contributed to X in the proposed transaction are diversified portfolios of stocks
and securities within the meaning of § 368(a)(2)(F)(ii). X represents that the Partners
would contribute cash to X that constitutes no more than n% of the total value of the
assets contributed to X in the proposed transaction.
LAW AND ANALYSIS
Section 721(a) of the Code provides that no gain or loss shall be recognized to a
partnership or to any of its partners in the case of a contribution of property to the
partnership in exchange for an interest in the partnership.
Section 721(b) provides that section 721(a) will not apply to gain realized on a
transfer of property to a partnership which would be treated as an investment company
(within the meaning of section 351 of the Code, if the partnership were incorporated).
Section 351(a) of the Code provides that no gain or loss will be recognized if
property is transferred to a corporation by one or more persons solely in exchange for
stock in such corporation and immediately after the exchange such person or persons
are in control of the corporation.
Section 351(e)(1) provides that the nonrecognition rule of section 351(a) does
not apply to “a transfer of property to an investment company.” The section further
provides that for purposes of the preceding sentence, the determination of whether a
company is an investment company shall be made by (A) taking into account all stock
and securities held by the company, and (B) by treating as stocks and securities:
money, stocks, other equity interests in a corporation and other listed items.
PLR-113817-25 3
Section 1.351-1(c)(1) provides that a transfer of property will be considered to be
“a transfer to an investment company” if (i) the transfer results in diversification of the
transferor's interests and (ii) the transfer is made to a regulated investment company
(RIC), a real estate investment trust (REIT), or a corporation more than 80% of the
value of whose assets are held for investment and are readily marketable stocks or
securities.
Section 1.351-1(c)(2) provides that the determination of whether a company is an
investment company shall ordinarily be made immediately after the transfer, but if the
circumstances change thereafter pursuant to a plan in existence at the time of the
transfer, this determination shall be made by reference to the later circumstances.
Section 1.351-1(c)(5) provides that a transfer ordinarily results in diversification if
two or more persons transfer nonidentical assets to a corporation in the exchange. If
any transaction involves one or more transfers of nonidentical assets which, taken in the
aggregate, constitute an insignificant portion of the total value of the assets transferred,
such transfer shall be disregarded in determining whether diversification has occurred.
Section 1.351-1(c)(6)(i) provides that a transfer of stocks and securities will not
be treated as resulting in diversification if each transferor transfers a diversified portfolio
of stocks and securities. A portfolio of stocks and securities is diversified if it satisfies
the 25 percent and 50 percent tests of § 368(a)(2)(F)(ii), applying the relevant
provisions of § 368(a)(2)(F). For this purpose, government securities are included in
determining total assets, unless the government securities are acquired to meet
§ 368(a)(2)(F)(ii).
CONCLUSION
Based solely on the facts submitted and representations made, we conclude that
if X were incorporated, it would be an investment company under § 351(e)(1) at the time
of the proposed transaction. We further conclude that the proposed transaction to
contribute the specific assets identified in the ruling request will not result in the
diversification of the transferors' interests within the meaning of § 1.351-1(c)(1)(i).
Therefore, no gain will be recognized by the Partners under § 721 on their contribution
of investment assets and cash to X.
The ruling contained in this letter is based upon information and representations
submitted by X’s authorized representative and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of the
material submitted in support of the requested ruling, it is subject to verification on
examination.
This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent.
PLR-113817-25 4
In accordance with a power of attorney on file with this office, we are sending a
copy of this letter to X’s authorized representative.
Sincerely,
Robert D. Alinsky
______________________________
Robert D. Alinsky
Branch Chief, Branch 3
Office of the Associate Chief Counsel
(Passthroughs, Trusts, and Estates)
Enclosure:
Copy of this letter for § 6110 purposes
cc: ------------------
------------------------
----------------------------------------------
--------------------------------
---------------------------------
----------------------------------
--------------------------------------------------
---------------------------------------------------
-------