estate “inventory” into capital gains by contributing the real estate to a non-developer partnership before sale.EXAMPLE 19.22 Martha and Stuart Smith form MS, an equal partnership, with Martha contributing land lots held as inventory with a fair market value of $100,000, and an adjusted basis to her of $48,000. Stuart contributes $100,000 cash. MS holds the land for investment and, within 5 years from contribution, sells the land for $200,000. MS reports a $152,000 gain ($200,000 sales price – $48,000 inside basis). Martha receives an ordinary income allocation of $102,000 ($52,000 “built-in” gain plus $50,000, one-half of the balance of the gain). Stuart must report $50,000 of gain as ordinary income. If the land had been held more than 5 years from contribution, the character of the gain allocated to Martha and Stuart would have been capital instead of ordinary.Code Sec. 724(d)(2) defines “inventory items” to include those which, if sold, generate ordinary income rather than capital gain. But land or depreciable property used by a partner in a trade or business prior to its contribution to the partnership is excluded from the definition of “inventory items.” For this purpose there is no requirement that this type of property (generally Section 1231 property) must be held for more than 12 months prior to its contribution to the partnership.EXAMPLE 19.23 Mr. Kostock owned a desk which he had used entirely in his sole proprietorship for 11 months when he contributed it to his newly formed partnership as a part of his capital contribution. If Mr. Kostock had sold the desk, any gain or loss would be ordinary since the desk would not qualify as Section 1231 property. However, if the partnership continues the business use of the desk for more than one more month and then sells it at more than its original cost to Mr. Kostock, the gain in excess of the depreciation recapture will qualify as a Section 1231 gain.