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Sale of LLC Membership Interest & Positive Capital Acct

Technical topics regarding tax preparation.
#1
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10
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2-May-2018 10:28am
Location:
CA
Hi All,

I have a situation, which I am sure has already been addressed on here (haven't been able to find the answer yet), of a member of an LLC who sold his membership interest for $1 and left a positive capital account balance of 100k when sold his membership interest to the other partners (no liabilities on the books). To make a long story short, LLC with 2 partners A and B- A loans 500k to the business and B contributes no dollars but the know how and contacts of the business concept. They struggled to get along together after 2 years, he decided to sell his membership interest for $1 and recuperate some of the money loaned (and the remaining loan balance was converted to capital as part of the sale of the LLC interest). the positive capital account balance when he sold was 200k (part of the litigation was he could not repay himself for a while and so as part of the sale agreement he could repay himself an extra 100k) .

1- the positive capital account balance on the books and K-1 is transferred to the other partner correct? just a book adjustment I know , does not really reflect outside basis.
2- is there a situation where the remaining positive capital account balance creates taxable income for the other partner?
3- how does the selling partner's remaining positive capital account balance affect the other partner? He is assuming basis of assets he as never bought or invested in- so his outside basis is still zero?
4- the partner sold his interest and another partner quickly came in right after so it is NOT a termination of LLC.

Thank you!
 

#2
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Location:
CA
Anybody please? I need to wrap this up today and I am lost. thank you!
 

#3
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Location:
North Country, USA
Transfer of capital balance generally not an income event (unless the only item in the partnership is cash). If the entity has only one owner for even a day, then it is technically a disregarded entity at that point. There must be 2 members perpetually for the entire year to avoid the partnership termination on the exit of the first member. The fact that the "LLC" didn't terminate doesn't mean that the partnership didn't terminate.

This is a complicated question - there are the basis adjustment rules under section 743(b) and section 754 to consider. If there are partnership liabilities, those are transferred by the outgoing partner (treated as a distribution) and additional basis for the partner to whom they are allocated. If you don't have a tax basis balance sheet, it's pretty difficult to figure out the tax accounting for the admission of the new partner.

1. The positive capital account balance transfers to someone. If the partnership remains in existence, it transfers to whichever partner (A or C) acquires it. Correct, tax capital does not equal basis.
2. see above - most likely not unless the only balance sheet item is cash.
3. Outside basis is zero if paid zero, plus assumed liabilities. (Inside) Tax capital does not reset.
4. "quickly came in right after" sounds problematic...if outgoing partner transferred his interest to remaining partner, that is a rev rul 99-6, situation 1 transaction (partnership termination). Partner C acquiring an interest from remaining partner or from LLC is a partnership formation transaction under rev rul 99-5, situation 1 or 2 (depending on the facts). Only way this doesn't terminate is if C became a member before outgoing member left, or if outgoing member transferred his interest to C.
 

#4
Nilodop  
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Pennsylvania
Arm's length sale transaction or gift?
 

#5
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2-May-2018 10:28am
Location:
CA
yes it is an arm's length transaction.

In terms of the partnership termination, my issue is that yes this is a termination for a while until another partner came along few months later- the hassle of going through a termination for 6 months and go back to partnership treatment is most likely going to confuse the irs and ftb (CA) and probably some notices. do you think treating this as a partnership with special allocations for the whole year is a a big problem? i know that if entity becomes disregarded everything is treated as a distribution to the remaining partner as soon as it becomes disregarded so that would create income to the remaining partner (distribution in excess of basis?)- anyway my goal is to prevent the partnership termination if possible

In terms of balance sheet on a tax basis- items are cash, fully depreciated equipment, some minor liabilities such as customer dposits - that's about it. in what circumstances would that create income to the remaining partner?

I have heard on here that you are supposed to create a phantom liability account and offset the positive capital account balance to that phantom liability account.

thank you for your help!
 

#6
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Location:
North Country, USA
I would file the final 1065 for the first period with a statement saying the entity became disregarded on XX date.

Distribution is taxable on a termination (ie, liquidating distribution) to the extent cash and equivalents exceed the partner’s outside basis. Other assets are stepped-down (or up) to equal the partner’s outside basis. Assuming acquiring partner is a 50% owner, he’d be treating as receiving a liquidating distribution of one half the partnerships assets and liabilities, and purchasing the other half for cash paid plus assumed liabilities.

It’s actually much more complicated (in my opinion) to not follow the termination step followed by the new partnership formation. With a termination followed by formation of a new partnership, inside and outside bases should be equal.

As far as the phantom liability comment, I have no idea what that would be. There is a concept of contingent liabilities, but those generally have no tax basis.
 

#7
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2-May-2018 10:28am
Location:
CA
so if BS looks like this, how would you calculate the tax on distribution to the remaining partner?

ASSETS:
Cash 29k
Equipment 90k
A/D (90K)
Sec Deposit 10k

LIABILITIES & EQUITY

Customer Deposit 23k
CAPITAL ACCOUNTS 16K

the remaining partner did not put any money, has a negative capital account of -130k (no basis so losses are suspended), partner that is being bought out has a positive capital account left of 146k when leaving.

1- I would tend to think that reminaing partner should be taxed on 16k of liquidating distribution?
2- do I zero out everything on the final LLC return or leave balances as is? i know CPAs do it differently.

thanks for your help!
 

#8
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102
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Location:
North Country, USA
Assuming the security deposit isn't cash, and the customer deposits are liabilities for tax purposes, I would expect Remaining Partner to receive a distribution of 1/2 the assets, and have a gain of $3k for the cash > liabilities, with zero basis in the equipment and security deposit.

For the $1 buyout, the economics don't make sense (logically, but this happens frequently where the inside tax basis is way over the FMV of the partnership interest)...but since the taxpayer is getting another $3k of cash, which is in excess of his $1 purchase price, there would be $2,999 in gain. There is an argument that there must be a contingent liability (why would anyone sell $3,000 for $1), but in the absence of contrary guidance, I think the answer would be there is a gain.

So it would seem like total gain of $5,999.

New partnership formation (assuming no change to the amounts above) - Remaining Partner contributes net assets totaling $6k, his tax capital is $6k.

Partnership's basis in contributed assets = $29k (cash), basis in contributed liabilities = $23k. Inside tax capital attributable to Remaining Partner's contribution = $6k. Other assets have an inside tax basis of $0.

HIS 704(b) CAPITAL SHOULD BE CALCULATED. This would determine his share of distributions based on the FMV of contributions to the new partnership.

Side note - Outgoing partner is getting a bad tax answer, he will have a huge capital loss it would seem...
 


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