Trust Transferring Property to LLC

[JohnH]

Taxpayer owns a 50% interest in a rental property. His deceased wife's trust owns the other half. Lawyer wants to form an LLC and have taxpayer and trust deed each of their interests to the LLC. The taxpayer and the trust will be the only members of the LLC, with each still owning 50%. Are there tax consequences to this transaction?

[Koss]

Transfer to Trust

I gotta think about this one long and hard, but my knee-jerk reaction is--

The transfers will not be a taxable event right now. Probably not even a gift tax. In other words, no capital gain or loss. It's definitely not a sale. I'm assuming it would be treated as a gift, but I don't think there would be a need for a gift tax return.

It could have a significant impact on--

Basis
Depreciation
Passive losses
AMT

etc.

These consequences could be felt as early as the filing of tax returns for 2012.

The consequences may not be negative. Just need to be aware, and figure out what they are.

And make sure the attorney is not planning to make the LLC into an S-corp. There are a million reasons that rental real estate should not be in an S-corp.


BMK

[Gary2]

It wouldn't be a gift, for the same reason that forming a partnership by contributing property as capital isn't a gift.

And that's the real question I'd have, does this create a partnership, with the extra paperwork, along with limitations on exchanging interests, etc. Depending on the cost of an LLC in your state, and assuming the reason for the LLC is liability, it may make sense to form two separate LLCs, one for the trust, one for the taxpayer. Each would be disregarded, so no (federal) tax implications, while still getting the liability protection.

Is the taxpayer also the trustee? And what is the purpose of the trust?

[Koss]

Not a gift

Gary2 is right...

I was confused thinking about the trust. Transfers into a trust are almost always gifts. But this would be a transfer from the trust. And it is not a distribution to a beneficiary. As Gary2 noted, it is a capital contribution.

BMK

[JohnH]

The lawyer contacted me last Friday about this, and we had a meeting yesterday. So right now I'm just trying to assimilate everything. I am grateful they brought me into the conversation before finalizing everything, but at the same time it places a little pressure on me to get answers quickly. Thus this post, along with my own research.

Definitely S-cop is out for the LLC. I'm wondering if Disregarded Entity might work better than Parrtnership for the LLC. As I see it, nothing has changed from a tax standpoint (providing we agree that this is not a taxable event), so Disregarded Entity would simply eliminate the need for another tax return.

If anyone has any thoughts on that line of reasoning I'd appreciate the input.

[Koss]

Disregarded entity?

I don't see how that would work...

With respect to an LLC, it is only a disregarded entity when it is a single-member LLC. It is treated as a sole proprietorship if no election is made.

If it is a multi-member LLC, the default treatment is partnership taxation, and it would actually have to file a 1065.

It can't be a sole prop if it has more than one member.

BMK

[Gary2]

With respect to an LLC, it is only a disregarded entity when it is a single-member LLC. It is treated as a sole proprietorship if no election is made.

If it is a multi-member LLC, the default treatment is partnership taxation, and it would actually have to file a 1065.

It can't be a sole prop if it has more than one member.

This is precisely why I suggest having each share put into a separate LLC - again, depending on the annual LLC cost in that state.

[Koss]

Separate LLCs

I did not read Gary2's post carefully enough.

If each share is put into a separate LLC, then, yes, each LLC would be a single-member LLC, and each LLC could be a disregarded entity.

BMK

[Burke]

I suppose the lawyer has probably addressed this, but the TP wants to make sure it does not violate the terms (or intent) of the trust. For instance, why was her half-interest in the trust to begin with? And so forth.

[JohnH]

Yes, the lawyer was very specific in pointing out that the arrangement does not violate the terms of the trust.

Confession time here - I have handled several single-member LLC's as Disregarded Entities, but I haven't handled any multi-member LLC's to this point. In my haste I just assumed a multi-member LLC could do the same (disregarded entity) if it defaulted to a partnership. So thanks for helping me catch the error before I went too far down that rabbit trail - without your input I would have probably discovered it just after I spent an hour explaining to everyone why it's such a good idea. Much better to be red-faced here than in a client/lawyer meeting.