Partnership Complete Liquidation

Technical topics regarding tax preparation.
#1
jcpa  
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My client is a 4 person LLC and on the books is an installment receivable of $500,000 with a deferred gain liability of $150,000 and also equipment with cost of 100,000 and accumulated depreciation of $25,000.

The client wants to do a complete liquidation and distribute the installment receivable, deferred gain liability and equipment out to the 4 members.

Question 1: will the distribution of the installment obligation be considered a disposition at the LLC level and cause the deferred gain to be recognized at the LLC level and then passed thru to the members as income, or can the members receive the instalment note and deferred gain and pay tax as the note is collected?

Question 2: will the LLC have to recapture any depreciation on the equipment on distribution since depreciation is considered as a hot asset under Section 751(when the equipment is distributed disproportionately, which it will be, not IAW with the ownership %'s)?

Thanks for any help.
 

#2
MWPXYZ  
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I assume that the distribution of an installment note (from an installment sale of 1250 assets) to the partners is not a taxable distribution.

However, I have just read Prop. Regs. Sec. 1.453B-1(c), issued after Rev. Rul. 73-423; which indicates a tightening of the non-recognition rules regarding the distribution of an installment note.

Based on the Prop Reg, 1.453B-1(c)(1)(i)(C) it appears that the distribution from a partnership to the partners in a liquidation of the a partnership remains a nontaxable event for the sale of 1250 property. 1.453B-1(c)(1)(ii) lists two exceptions to the nontaxable event rule since "Paragraph (c)(1)(i) of this section does not apply to a disposition that results in a satisfaction of an installment obligation. . .

Two examples are given, yet the rule regarding the satisfaction of an installment obligation is not limited to the two examples.

So, is a distribution of an installment note (from an installment sale of 1250 assets) to the partners not a taxable distribution?
 

#3
jcpa  
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MWPXYZ,

I got a little lost in your above explanation but it seems that the distribution appears not to be taxable under 453:

According to the IRS, proposed regulations "republish" in Prop. Regs. Sec. 1.453B-1(c) the general rule of Regs. Sec. 1.453-9(c)(2) to the extent that it provides for nonrecognition of gain or loss in certain dispositions, such as distributions from partnerships to partners under Sec. 731, no gain shall be recognized to a distributee partner with respect to a distribution of property (other than money)until he sells or otherwise disposes of such property.

Do you agree or disagree, I'm not sure which way you are going.

Thanks for your reply and hopefully a future reply as we will be liquidating the LLC as of this December 31, 2021.
 

#4
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The disproportionate distribution of a 1245 asset creates issues. The recipient would not get as much of the installment note. So it looks like it would be taxed as an exchange of part of an installment note for 75% of the equipment.
Steve
 

#5
MWPXYZ  
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Unfortunately for you I am merely re-asking your question, although I have limited my question to 1250 property.

I am assuming that the installment obligation is NOT satisfied by a mere distribution to the partners and thus the Section 731 distribution of the installment obligation is NOT a taxable event.

For some reason the Proposed Reg has got me (over) thinking the tax treatment.

I would assume that if it is the installment obligation that is distributed and not the assets themselves, the gain associated with that asset would be taxable income of the LLC and that the Gross Profit Percentage of the obligation for each member would reflect just the 1231/capital gain. OTOH, if the assets were distributed and then sold, each member would report their share of the 1245 gain. Do you actually have a case where the 1245 assets are distributed (and sold) AND an installment obligation is distributed as well?

My own tax problem is due to a level of informality that has me calling lawyers for each party to see who the seller was and who will receive 1099-S forms.
 

#6
jcpa  
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MWPXYZ and others:

In my original post I was asking 2 different and unrelated questions that are part of a complete liquidation of an LLC. I'll rephrase the question and only include the distribution of the installment obligation(forget any question about depreciation recapture on an unrelated sale of depreciable equipment). The original sale was for bare land(no structures, no depreciation)2 years ago and so is an obligation that occurred prior to the year of complete liquidation. My research shows that ordinarily the obligation upon distribution to a withdrawing member(not a complete liquidation of the LLC, just that members interest)would be taxable upon distribution but if another code section allows non taxable treatment upon distribution then the deferred income is not taxed on distribution. Section 731 seems to be an exception due to the no gain/loss on distribution in a complete liquidation. The obligation may be distributed in a complete liquidation to the LLC members tax free under Section 731, i.e.: this is not an event that triggers the installment gain of $150,000 at the LLC level and each member can continue to collect the payments and recognize the income(and interest)each year of collection.

Also, the LLC has been in existence for 8 years so there are no built in gain on contribution issues for my LLC.

In your case MWPXYZ, if the sale took place inside the LLC the LLC would be the seller and Form 1099 would be in the LLC name, if the property was distributed to the members first and then sold the Forms 1099 would be in each individual sellers name as it occurred outside the LLC. You don't mention if your LLC is doing a complete liquidation to which Section 731 would apply.

Can anyone comment on my above rephrased question regarding the distribution of a prior year installment obligation in a current year complete liquidation under Section 731?

Thanks
 

#7
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jcpa - I agree with your assessment in post #3 that Reg. Sec. 1.453-9(c)(2) is applicable and that the distribution does not trigger recognition of gain under Sec. 453B.

You may also want to look at the IRS' reasoning on this in PLR 9620020.
 

#8
jcpa  
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Thanks Verytaxing, PLR 9620020 is very helpful.

PLR 9620020 does say 'Taxpayer intends to liquidate Partnership and distribute, pursuant to section 731, all of its assets to the partners in proportion to each partner's ownership interest' - in my case the installment obligation and receivable will be distributed in proportion to ownership interest on a fair market value basis in total(each member will receive 25% of the total fair market value of the LLC), but the distribution of the installment obligation and other assets using cost basis to the LLC may not be in proportion to 25% of each separate asset.

In your opinion does the disproportionate distribution at cost cause any tax issues?

Thanks
 

#9
sjrcpa  
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jcpa wrote:the distribution of the installment obligation and other assets using cost basis to the LLC

I believe assets are distributed at FMV, but carry the LLC's basis.
 

#10
jcpa  
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Thanks sjrcpa: I agree with your statement, but are you saying that as long as a partner receives his for instance 25% share of total assets at FMV then he does not have to take a 25% interest in each individual asset the partnership owns? For instance if the FMV of partnership is $100,000 then he takes 25% or $25,000 in value which could be all cash, a piece of equipment etc. and does not have to take a 25% of each separate individual asset?

I want to show a FMV distribution of assets at ownership % on the workpapers , but each partner wants to take specific assets such as all land, all cash, a combination of assets, etc. and not a % of each asset at partnership cost which may result in increasing or decreasing distributed cost basis to agree to the ending outside basis of each partner.

I want to make sure there are no tax issues with how the partnership assets are distributed in the complete liquidation of the partnership.
 

#11
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I would keep in mind 751(b). Are any of the assets unrealized receivables or substantially appreciated inventory?
 

#12
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As Permanently-Diff noted, you will need to be aware of triggering Sec. 751 on the hot assets when making disproportionate distributions.
 

#13
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My sense is that proportionate distributions are tax free under 731 and that distributions are taxable exchanges to the extent disproportionate.
Steve
 

#14
jcpa  
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Thanks, yes, there will be Section 751(b) depreciation recapture. I think that even if all assets are distributed disproportionately the only tax issues will be the Section 751(b) items. If there were no Section 751(b) assets then there probably are no tax effects even if assets are distributed disproportionately.

Many of you have probably had clients who completely liquidated their partnership/LLC - how did you handle the distributions?
 

#15
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jcpa wrote:Many of you have probably had clients who completely liquidated their partnership/LLC - how did you handle the distributions?


The liquidation of the partnership should be detailed in the operating agreement.
 

#16
sjrcpa  
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Re #10 I was just pointing out that the amount of the distributions is FMV and not basis.

I mainly have service businesses so I hardly ever see distributions of equipment.
 

#17
jcpa  
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Thanks for all of the replies. See the following which supports my thought on the non taxability of disproportionate partnership or LLC distributions(as long as there are no Section 751 assets involved or excess cash distributed):

From CPA Journal Online: http://archives.cpajournal.com/1997/049 ... es/f30.htm

"A disproportionate distribution is one which changes a member's proportionate share of LLC ordinary income assets, specifically unrealized receivables and substantially appreciated inventory."

From CPA Journal Online: http://archives.cpajournal.com/1997/049 ... es/f30.htm

"Disproportionate Distributions: In a disproportionate distribution, the LLC distributes to a member more or less than the member's share of ordinary income-producing property [defined in IRC section 751(a) as unrealized receivables or substantially appreciated inventory]. When either a current or liquidating disproportionate distribution is made, IRC section 751 applies to prevent the shifting of ordinary income among the LLC's members."

So if we have a complete liquidation of a partnership and assets are distributed disproportionately and there are no ordinary income producing assets(A/R, depreciable assets, inventory etc.)then I take the position that there are zero income tax effects of the disproportionate distributions(unless cash distributed exceeds basis on liquidation).

Though the above is from an older article, I have seen this same definition in many newer or fairly current articles.

Could someone weigh in on this interpretation?
 

#18
Nilodop  
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It's correct.
 

#19
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Wait jcpa, didn't your original post mention ordinary income producing property? Here's from your original post:
The client wants to do a complete liquidation and distribute the installment receivable, deferred gain liability and equipment out to the 4 members.

Question 2: will the LLC have to recapture any depreciation on the equipment on distribution since depreciation is considered as a hot asset under Section 751(when the equipment is distributed disproportionately, which it will be, not IAW with the ownership %'s)?

But then in your last post you said
So if we have a complete liquidation of a partnership and assets are distributed disproportionately and there are no ordinary income producing assets(A/R, depreciable assets, inventory etc.)then I take the position that there are zero income tax effects of the disproportionate distributions(unless cash distributed exceeds basis on liquidation).

Does the partnership have ordinary income producing assets? Wouldn't making a disproportionate distribution of these assets trigger 751(b)?
 

#20
jcpa  
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Permanently-Diff - you are correct that in my original question I had included 2 different questions, one regarding distribution of installment obligations and another asking about Section 751. I was getting confused with some of the answers so I rephrased the question in #6 just to address the installment obligation which was for bare land in a prior year and left out the question on Section 751 assets. I wanted a clear answer on the installment sale disproportionate distribution in a complete liquidation issue so yes I changed the parameters of the question. Perhaps I should have just started a new topic and asked just that question.

Thanks
 

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