Purchased LLC interest with negative capital account

Technical topics regarding tax preparation.
#1
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A 1065 client purchased an interest in an LLC in 2020 for $50,000 from an exiting member. On my client's K-1 there is no capital contribution because it went to the exiting member so that is our outside basis adjustment. But the exiting member had a negative capital account to the tune of $150,000 which was transferred to my client. The activity reported a net loss of $100,000 for 2020, so now my client has a capital account of (250,000) and outside basis adjustment of 50,000.

How is this 150,000 difference accounted for on my client's tax return and books?

I did a search but only found discussions relating to how to book the sale on the LLC tax return and books. I'm sure this is pretty basic and discussed somewhere I just can't seem to find it today.
 

#2
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Did the partnership have a 754 election in effect? Is there an amount in Box 11 or 13 noting "743(b) adjustment"?

It sounds like the didn't...at least they didn't prepare the K-1 with that in mind.

If that's the case, you have an inside/outside basis difference and it will be reconciled when your client disposes of their interest.
~Captcook
 

#3
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No elections made as far as I can tell

So what would happen if this taxpayer sold their interest this year for 50,000? Their outside basis would show no gain or loss due to the 50,000 purchase. But they would be relieved of a 150,000 negative capital account. How does that get accounted for?
 

#4
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They're only relieved of the debt they are allocated...not the balance of the capital account.

Let's presume they are allocated $150K of debt and that allocation hasn't changed in the time they've owned their interest, just to make things simple.

Their initial basis would have been $200K ($50K cash paid + $150K allocated debt). They deducted a $100K loss in 2020, which reduced their basis from $200K to $100K. If they sold their interest for $50K, the gain calculation would be as follows:

Gross proceeds= $200K ($50K cash received + $150K debt relief)
Basis= $100K ($50K original investment + $150K allocated debt - $100K deducted loss)
Gain = $100K, which equals the loss they deducted in 2020 since all other variables haven't changed.
~Captcook
 

#5
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All makes sense, thanks.

So for balance sheet purposes would you ignore the negative capital account? What i mean is, on my clients 1065 we have to list the investment in this other entity. Normally that investment will equal the capital account but in this case it doesn't. Would you just keep a note in the file that the investment was 50,000 less the 100,000 current year loss and ignore the 150,000 negative capital account adjustment?
 

#6
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In your case, yes.
~Captcook
 


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