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**Bees Knees** · 01-18-2008, 09:18 AM

Good questions.

Will the 81% owner's gain include the assumption of liabilities since he is still a co-signer on the loan's? How about as they pay off the loan's....does he then have gain? Does his gain include the repayment of the personal loans?

An LLC, taxed as a partnership is not like an S corporation. Personal guarantees add to basis in a partnership. They do not in an S corporation.

Thus, as long as a partner has a personal guarantee out there, it adds to basis. So in your example, the 81% member would get basis in the personal guarantee and thus reduce gain when his (or her) units are sold. The buyer could renege on his (or her) agreement to assume the liabilities. Thus, the 81% member still gets basis.

Thus, if and when the loan is in fact repaid by the buyer, the 81% member would have to recapture the gain as at-risk basis drops below zero (see TTB, page 7-14). It thus basically delays the gain the 81% member would have paid had he (or she) had the personal loan guarantee removed at the time of sale.

What happens to the current year losses thru October for both parties? I assume that the 19% member does not get any benefit of yr 1 or yr 2 losses since he had no financial investment.

That is correct. The sale does not free up suspended at-risk losses. Those losses are lost forever as the member was never at-risk for them. The other 81% member however gets the losses assuming there is basis.

The accountant for the new owner intends to file one 1065. Is this correct? Does the sale of all units require a cut-off at that date and the filing of a second 1065? Does the sale of all units terminate the LLC?

TTB, page SB4-13 says

A partnership terminates when one of the following events takes
place.
1) All the partnership operations are discontinued and no part of
any business, financial operation, or venture is continued by
any of its partners in a partnership.
2) At least 50% of the total interest in partnership capital and
profits is sold or exchanged within a 12-month period, including
a sale or exchange to another partner.
Effect of termination by sale or exchange. If a partnership is terminated
by a sale or exchange of an interest, the partnership is deemed
to have contributed all of its assets and liabilities to a new partnership
in exchange for an interest in the new partnership. Immediately
thereafter, the terminated partnership is deemed to
have distributed interests in the new partnership to the purchasing
partner and the other remaining partners in proportion to
their respective interests in the terminated partnership, in liquidation
of the terminating partnership. [Reg. §1.708-1(b)(4)]

These means two short year partnership returns must be filed; one for the old partners up to the date of termination, and a second for the new partners (if it is still a partnership) for the date of sale to the end of the tax year. If there is only one member in the LLC after the date of sale, that one member cannot file as a partnership. He (or she) would either have to file a Schedule C as a disregarded entity, or elect to be taxed as a corporation.

Finally, the buyer's intent is to keep the old LLC to hold the patents, etc. They also set up a new corporation and issued shares in this new corp. to both of the original members of the LLC. I assume this could be considered "stock for stock" and no gain reported on these shares until and unless they are eventually sold.

Depends. To get stock in a new corporation tax free, it has to pass the Section 351 test, meaning the new stock holders as a group of stockholders have to own at least 80% after the transfer (which they probably do).

Trading a partnership interest for stock in a corporation is not a stock for stock transaction.

I’m not exactly sure what you mean by this. Is the LLC a separate entity than the new corporation, or are they suppose to be the same?

**LMathey** · 01-18-2008, 10:34 AM

Issuance of shares in new corporation

First of all, let me thank you very much for your responses. I really appreciate you taking the time to answer my questions.

The buyer intends to keep the old LLC alive because all the patents, licenses, etc. were issued under it's federal ID number. In addition, they also set up a new corporation which will now be the production company. The buyer kept over 80% of this stock for himself. The new corporation is privately held although their goal is to take it public.

The shares in the new corporation given as part of the purchase agreement between the buyer and seller have a par value per the purchase agreement of .0001 per share. If they cannot be considered "stock for stock" can we use the par value and include that in proceeds? They were issued by the buyer's new corporation to the sellers to sweeten the pot in the event that the company goes public and makes it big.

Do I understand you correctly that the remaining amount of the loans gives her basis and reduces her current capital gain? For example she received $405,000 in cash but the remaining loans she is personally liable for are $193,000. In that scenario, her capital gain would be $212,000. Assume that due to favorable interest rates on the loans the buyer takes the full 10 years to pay off the loans, then each year until the principal payment exceeds the loan balance there would be no gain because she still had basis. Does that sound right?

Finally when the 81% owner gets her K-1 from the short year return is she precluded from taking the losses since she is using the loan guarantee as basis for the sale of the units? Do we have a choice as to how to use the basis provided by the loan guarantee? Obviously it would be more advantageous to use it to take the ordinary losses from the business than to reduce capital gain from sale of the units.

Thank you in advance for your assistance.

L Mathey

**Bees Knees** · 01-18-2008, 01:57 PM

The shares in the new corporation given as part of the purchase agreement between the buyer and seller have a par value per the purchase agreement of .0001 per share. If they cannot be considered "stock for stock" can we use the par value and include that in proceeds?

I’m not sure what the question is.

If this is a new corporation and both the buyer and seller get shares in the new corporation around the same time in the same transaction, then 100% of the stock will be owned by the contributing shareholders and thus qualify for tax free treatment under Section 351. Having said that, that does not make the sale of the LLC members interest in the old partnership tax free under Section 351. That part of the deal is still taxable, regardless of how the new corporation is structured.

Do I understand you correctly that the remaining amount of the loans gives her basis and reduces her current capital gain? For example she received $405,000 in cash but the remaining loans she is personally liable for are $193,000. In that scenario, her capital gain would be $212,000. Assume that due to favorable interest rates on the loans the buyer takes the full 10 years to pay off the loans, then each year until the principal payment exceeds the loan balance there would be no gain because she still had basis. Does that sound right?

No, what I am saying is she has basis in the loans when her interest is sold, thus reducing her capital gain. Using debt basis to reduce gain on the sale also reduces her basis to zero after the sale. Thus, as principal is paid on the debt, her basis in the debt that went to zero after the sale, now goes negative, which triggers gain. In other words, after the sale, she has gain each time her debt basis goes below zero as a result of the loan being paid off.

Example, cash sale of $405,000 minus basis of $193,000 = $212,000 gain upon sale. Her basis in the $193,000 debt that she is still liable for is zero after the sale. If the buyer reneged on the debt and she had to personally pay it back, she would get no deduction for the payment, as she already used that basis to reduce her gain down from $405,000 to $212,000. If the buyer does pay the debt off, here basis in the debt, which is now zero, is reduced each time the debt is paid off and she is relieved of the liability. Since basis in something can never go below zero, she has taxable gain on the amount needed to keep her basis out of the hole. So if the buyer eventually does pay all the $193,000 debt off, she will eventually have $193,000 of gain to report. $212,000 original gain + $193,000 of gain from debt relief = $405,000, which is the amount of gain she originally would have had if she had zero basis in the debt to begin with.

Finally when the 81% owner gets her K-1 from the short year return is she precluded from taking the losses since she is using the loan guarantee as basis for the sale of the units? Do we have a choice as to how to use the basis provided by the loan guarantee? Obviously it would be more advantageous to use it to take the ordinary losses from the business than to reduce capital gain from sale of the units.

She would use her basis in the debt to deduct losses from the K-1 before using against the sale proceeds on the sale of her interest.

**LMathey** · 01-19-2008, 06:02 PM

Receipt of shares in new corporation

The question which was not presented clearly was whether the stock received as part of the sale of the LLC units needs to be included in proceeds for the seller. If yes then how do I value them? Can I use the par value of .001 since the new corp has very few assets? Both sellers were issued shares as part of the sales price. Since stock in a corporation and units in an LLC are two different "animals" and it cannot be considered as stock for stock I assumed he had to pick up something as proceeds.

Thanks again for all your help.

**Bees Knees** · 01-19-2008, 11:57 PM

OK so now it is clear. Part of the "money" received for selling the LLC is shares of stock in a new corporation. The sellers must recognize gain on the sale based upon the FMV of the stock received in exchange for their LLC units.

As to what that is worth, par value really does not mean anything. You can say par value is anything you want. All the IRS cares about is what is it worth. Not what its par value is.

If it is really worth .001 per share, then that is what it is worth. If it is worth $10 per share with a par value of .001 per share, then it is worth $10 per share. Somebody has to be able to put a value on the stock received in order to determine what the gain or loss is on selling the LLC units. And I don't think that somebody is you. I think you have to let the sellers and buyer agree as to the value and tell you what it is.

**LMathey** · 01-21-2008, 03:26 PM

Thank you

That is what I have done. The purchase agreement says that the buyer is to furnish the seller with the details of the purchase price within 60 days after closing. That allows time to adjust A/R, A/P etc.

Right now I am just waiting on their reconciliation as to what value they assign to the stock in the new corporation, etc.

Thanks again for being there and being willing to take the time to answer my questions. Happy tax season!

Linda Mathey

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