2 Brothers Exchanging Businesses

Technical topics regarding tax preparation.
#1
Wiles  
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Maybe there is some advanced tax planning / entity structuring ideas here...

My clients, two brothers, own two business together - both 50/50. One is a C-Corp retail operation. The other is an LLC (partnership) that owns a commercial building. The commercial building is unrelated to the retail operation.

One brother wants to retire and they want to structure so that the retiring brother will get 100% of the LLC and the non-retiring brother will get the C-Corp. Can you think of a way to conduct this exchange tax free?

I have thought about electing C-Corp status for the LLC in order to do a tax free reorganization, but before I even figure out if this will meet the requirements, this idea breaks the rule of putting real estate in a corporation.
 

#2
JR1  
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Well, since WE know you can't do a 1031 between related parties, lol...how about gifts? Yes, you'd have to file 709's...and they're trading basis, then, as well....

Create a C corp? Say you didn't say that...lol.
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#3
Nilodop  
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Using either a new partnership or amending the old partnership agreement, (and by partnership I mean I don't care if it's an LLC or not), contribute the stock of the C corp (and, if it's a new entity, the LLC interests), to it. Have the agreement allocate income and loss strictly according to who runs the respective operations, i.e., special allocation under 704(a) and (b), and take (c) into consideration as to who gets what when one or the other asset is sold or distributed.

Do I know this works? Nope, but there are some really good partnership members of TPT who know.
 

#4
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I would start by modeling out the bottom line economics of a fully taxable "simple" cross sale between parties. This provides a starting point for what would be due to each party post-tax.

Taking that information...work back up to how to structure the transaction to minimize taxes. It's unlikely to be completely tax-free, but you can likely minimize taxes greatly and maximize value transferred by using installment sales, allocations of operating income (from rental), increased salaries/retirement contributions, etc.
Lots of levers to pull...

If you share some values/basis/income, we could help to work through it...
~Captcook
 

#5
Wiles  
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Thank you for the responses!!!

Let's explore Nilodop's idea in #3. Let's say we created a new partnership and contributed both assets. After several years, can we liquidate that partnership and send the assets out according to their wishes.

I know there is some 7-year partnership thing that folks can do with their highly appreciated stocks. Whatever this is called? Can this work here?

The C-Corp does not issue a dividend. The LLC generates & distributes $60K of income. Instead of messing with income allocations, they can keep the retiring brother on payroll in the C-Corp @ $30K/year.
 

#6
JAD  
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The risk is in the economic reality that you have laid out - they currently are 50/50 owners of each company, and they want to change to 100% owners. Absent a specific rule that allows escape from taxation, such as a tax-free reorganization, it sounds like a sale of interests in the companies. And there are traps in Subchapter K.

For example, 707(a)(2)(B) explains when contributions to capital will be treated as a sale.

Does the partnership have hot assets? If so, does the change in the partners' interests in hot assets trigger income recognition?

Does the corporation have NOLs? If so, 382 is an issue.
 

#7
Wiles  
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No hot assets in the LLC. No NOLs in the corporation.
 

#8
Wiles  
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The "7 year partnership thing" is found in IRC 704(c)(1)(b). This is an anti abuse provision and I am not sure if the 7-year period is a safe harbor or not.

My reading shows they would not be able to change the economic benefit of the contributed assets via special allocations during the 7 year period.
 

#9
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You’re on the right track. Here’s an article:

https://www.meltzerlippe.com/wp-content ... native.pdf
 

#10
Wiles  
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Ah hah! The “mixing bowl” or melting pot. There’s is nothing in the tax code as “American” as that. How can the IRS dare to challenge this?
 


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