Sale of LLC units with suspended losses

[LMathey]

I have a new client who owned 18% of the units in an LLC for two years. He put no money into the LLC nor did he sign personally on any of the loans. In year 1 his K-1 showed $10,000 of losses which he could not use due to lack of basis.

In 2007 there was a loss up to the time he sold his units. He got $80,000 which I think will be a LTCG with no basis.

What happens to the losses? They talked to another client that told him that he could reduce his gain by the losses but I did not think he could ever use the losses since he had no basis.

Am I having a "senior moment" or can he actually take the losses?

Any help would be appreciated.

L Mathey

[Jesse]

He can use the suspended losses against the $80,000.

[Roland Slugg]

Not so fast

Dear LMathey

You wrote: "He sold his units." You also wrote "He got $80,000."

Assuming you meant what you wrote, the investor sold his LLC units ... to one or more of the other investors, or to a third party ... receiving $80,000 from the buyer. If that's true, he may not offset the prior year's $10,000 loss. He had an $80,000 net gain. (Selling price $80,000 ... basis $0)

I also wonder about the 18% interest you say he owned without having investing any cash or guaranteeing any debt. How so? Have you considered the possible tax implications of that? It may be somewhat moot now that he has divested himself of that investment, but there may have been a taxable transaction when he originally received his LLC units.

[LMathey]

Yes he sold the units

He is a chemist. On his own he had developed a formula for a product. He was approached by someone to set up an LLC to develop the product and bring it to market. No value was assigned to his formula nor was there a patent. He received 18% of the units.The business was solely funded from loans that were signed personally by the other person who got 82% of the units.

In the first 1 1/2 years they lost money but proved the product was viable. An outside party bought his units for $80,000.

He had a loss from yr 1 of $10,000 and will have a similar loss on his K-1 for 2007.

With these additional facts, does he have a gain of $80,000 or can he offset it with the 2 yrs of losses?

[Roland Slugg]

An outside party bought his units for $80,000.

In with $0, out with $80,000. Isn't that a gain of $80,000? Don't be sidetracked by the $10,000 loss that appeared on last year's K-1 or by whatever amount that may appear on the 2007 K-1.

Now, it is possible that some of his gain may consist of ordinary income (unrealized receivables and inventory) or §1250 gain. See Code §741, 751(a), 751(c) and Regs §1.741-1(a).

[LMathey]

Thank you

Thank you I will review the code and Reg sections. There was some inventory but it was raw materials. Basically the purchaser wanted the formula once they had proved it worked.

I also thank you for confirming what I thought. Since the losses were suspended due to lack of basis he should not get them when he sells since he still has no basis. A different answer from passive losses suspended due to income limitations, etc.

Lmathey

[LMathey]

Section 751 a---R. Slugg please respond

I am finalizing the tax return and want to make sure that I report this sale of the partnership units correctly. This was an accrual based partnership. As such, the sales represented by accounts receivable were already reported on the K-1. Under Section 751 (c) they would not be considered as unrealized receivables. Therefore the only portion of the sales proceeds I need to report as ordinary would be the portion attributable to inventory

Am I correct that I must allocate the dollar amounts to the proceeds that represent the inventory and unrealized accounts receivable? I intended to have an attachment to the K-1 for each partner explaining that their proceeds included items covered by Section 751 (a) and that when they report them on their 1040 they need to report $x as long term capital gain and $x as ordinary income.

One final thing how do I get this on their return as ordinary income? Do I use Form 4797? If yes which part?

[Roland Slugg]

Just dropped in for a minute and saw your question. I don't have time to look anything up right now, but if you have one of the good desk reference books such as TTB or RIA's Federal Tax Handbook, it should have some examples to help you make the calculations. You are correct that since the business uses accrual basis, you won't have an allocation to unrealized receivables per se. However, the term "unrealized receivables" also includes depreciation recapture under ¶1245.

Report the ordinary income portion of the proceeds on F-4797, Part II.

Sorry I can't be of more help right now ... busy.