LLC Basis - Am I right ?

[MariaMc]

I have a client who will transfer real estate to an LLC. The property is worth less than he paid for it but I figured the property owner will retain his cost basis even after the transfer to the llc takes place. The LLC will have an additional partner who will buy a percentage of the real estate in the LLC over time. Would this result in a capital loss for the property owner since he will be selling his interest in the llc that owns the property for less than what he paid for the property ?

Please help....

Thanks,
Maria

[Nashville]

Entity

Maria, how is the LLC electing to be taxed? You say there will be an additional "partner", but you need the current owner to inform you how he has elected to be taxed (if at all).

The ownership of the property in question will take on different gain/loss characteristics depending on what kind of entity this is.

[MariaMc]

LLC Basis

Entity will be taxed as a partnership. The goal is for the property owner to transfer the property into the partnership and sell portions of his partnership interest to the other partner so that eventually the new partner will own the llc and therefore the entire property as well.

Does the property owner report a capital loss each year as he sell portions of his interest in the llc to the new partner? As I said, he property is worth less that what he paid for it.

[Snaggletooth]

Built-in Gain or Loss

Maria, the reporting entity is no longer the individual, but is now the partnership. A partnership is infinitely more complicated when the partners contribute property instead of cash, and this is the situation you have. Make sure your fee is sufficient to include all the extra reporting that you will have to do.

The situation is governed by Section 704. Even though the reporting entity is now the partnership, the resulting gain/loss on the land is allocated to the partner that contributed the land. And his "outside" basis is his cost and not the FMV. The "inside" basis to the partnership is the FMV.

Part of the additional accounting is that you will always have to reconcile the ongoing FMV versus the partner's historical cost until his interest is liquidated.

This is a complex subject. My best information comes from the Small Business version published by The Tax Book, if you have it, it begins on page 20-9. If you don't have it, the IRS has few specialized publications for entities as it does for individuals. Consult with Code Sections §722 §723 and §754. Built-in gains are in §704.

[MariaMc]

Makes Sense

Everything you say makes sense. I have the deluxe edition so hopefully the small business section will address this. Since the property owner has a loss in this property due to the real estate bubble, would he report a capital loss on his personal return as he sells his interest in the LLC to the new partner ?...Or does he wait until he is totally out of the llc to report the loss ?