A client made a transaction redeeming partnership interest in 2022 and I am just finding out about it. Facts below (simplified numbers for ease, not actual)--curious how you would handle this on the tax return books and K-1 footnotes for partners that were redeemed.
LLC was formed in year one, and $500k was put in by one LLC member for a 50% interest. Two other individuals put in $250k for 25% interest each. This LLC owns two properties and through cost seg bonus depreciation, it showed a $500k loss in year one, so the capital accounts were $250k (LLC) and $125k each for individuals.
At 1/1 of the following year, the individual interests were redeemed for $200k each, or $75k above their capital accounts. This was done 40% by the LLC that was already a member, and 10% by a new member.
Questions: If no 754 Election is made, the existing LLC member and new member would have outside basis totaling $150k, no current depreciation from special allocation, and that basis wouldn't be used until liquidation. The partners redeemed would report a $75k capital gain each, correct? No recapture.
If a 754 is made, I am unclear on the tax reporting. No financial statements are issued FYI, just a return. If a 754 election is made, I feel it falls under 734 adjustment for redemption above tax basis capital? $150k gets pro rata allocated to new 754 assets (some land, some building) and specially allocated. I think that part is somewhat straightforward.
1) Am I correct in the understanding that technically the 754 asset would not be on the tax return Sch L, and it would be outside basis reported by the partners and they need to keep track themselves? Since the partners redeemed were redeemed individually, technically they never went through the partnership and therefore this capital would not be on the return. Also, does the new (2020?) Tax Basis Method of capital account reporting impact this at all? It would seem I would have to force capital accounts if I don't report the 754 asset on the return, as I wouldn't credit capital accounts for the asset and I'd be out of balance.
2) The most logical option seems to be booking a new 754 asset (or several) on the books, crediting the partners' capital accounts for that amount, and allocating it out and depreciating it on the tax return. This would make sure things are tracked appropriately down the road for the partners, albeit maybe not technically correct reporting per the code? But it essentially accomplishes the same thing.
3) If a 754 is made by the partnership, are the individuals responsible to pick up "hot assets" depreciation recapture? The sale agreement was just a redemption of ownership interest, not the sale of the property. Or would they still have capital gain? If they need to pick up depreciation recapture, I would assume the footnotes would need to provide the information for them to do so.
Sorry for the long post, but curious on how you would handle. Thanks for any insight.