In general, the sale by a member of a limited liability company (“LLC”) interest is treated as the sale of an asset separate and distinct from the underlying assets owned by the LLC. Gain or loss is recognized based upon the difference between the amount received for the LLC interest and the tax basis in the LLC interest. A member’s tax basis in his or her LLC interest is equal to the amount of cash the member contributes to the LLC, the basis the member had in any property contributed, and the member’s share of the LLC’s debt. A member’s tax basis is increased by the member’s share of LLC income or gains and any additional contributions the member makes to the LLC. A member’s tax basis is decreased by any cash distributions the member receives, by the basis of property distributed to the member, and by net losses the member deducts. This gain or loss is considered gain or loss from the sale or exchange of a capital asset except if the gain is attributable to “unrealized receivables and inventory.” The determination of whether the capital gain or loss would be treated as long-term capital gains (held for more than one year and subject to a 15% tax rate) or short term capital gains (held for shorter than a year and subject to ordinary income tax rates) will depend on the selling member’s holding period. In general, the holding period would begin when the member acquires an interest in the LLC.
The purchase of a member’s interest in an LLC is treated as the purchase of an LLC interest separate and distinct from the purchase of the underlying assets of the LLC.
The purchase of an LLC interest requires that the buyer allocate the entire purchase price to the purchase of the interest. The tax basis of the purchasing member’s interest is determined under the basis provisions of the Internal Revenue Code and will be generally be the cost of the interest. The purchase, however, does not affect the tax basis of the assets already owned by the LLC. Thus, the purchasing member may be required to recognize a gain if there are appreciated assets owned by the LLC which are sold after the buyer becomes a member.
There is a provision in the Internal Revenue Code, Section 754, that allows the purchaser to adjust the proportionate share of the tax basis of the assets owned by the LLC so that purchasing member can adjust his or her basis of the LLC assets to reflect the purchase price paid for the LLC interest. The basis adjustment affects only the purchasing member and not the other members of the LLC. The Internal Revenue Code Section 754 election is an elective provision.
The sale by one of the members may or may not affect the remaining members. The sale by a member can affect the LLC and the remaining members if the sale causes the LLC to terminate. If 50% or more of the total interest in the LLC’s capital and profits are sold or exchanged, the LLC will be deemed to be terminated for tax purposes only. If the LLC is not terminated, the remaining members are not affected for tax purposes by the sale of an LLC interest.
Disclaimer: The information provided herein is not legal advice, but a general overview and should not be construed as legal advice.
Adam Bergman is the president and creator of http://www.MyLLCAgreement.com, the market’s leading online legal website that offers a customized LLC Operating Agreement for all types of businesses. Mr. Bergman has worked as a corporate and tax attorney at White & Case LLP, Dewey LeBoeuf LLP, and Thelen LLP, three of the most prominent corporate law firms in the United States where he advised thousands of entrepreneurs and business owners on a wide range of corporate and tax issues involving limited liability companies for the past seven years. Adam Bergman is recognized as a leading partnership tax expert and has lectured attorneys on the taxation of LLCs.