Sell of LLC interest in 3 member LLC

[David]

One LLC member wanted out and the LLC paid him $18,000 for his interest. The agreement says it is a redemption of debt. There is no debt, no hot assets and only fixed assets.

The member's capital account prior to the buy out was $6K. One of the remaining LLC members contributed $18K to the LLC in order to have a 2/3 interest and the remaining member still having a 1/3 interest.

The books recorded the $18K buyout as a distribution to the departing member. Therefore, the departing member's capital account has a $12K negative balance.

How is the negative $12K capital balance zeroed out on the balance sheet and on the tax return?

Thanks.

[Lee B]

This is one of the times where substance matters more than form.

So it needs to be recorded as a buyback of capital.

[David]

Thanks for your help. 

So when the member's negative $12K is reduced to zero where is the offset reported?

Thanks. 

[mircpa]

Don't the outgoing member report 12K as capital gain distributions  & the member who contributed has his capital account up by 18K & holding goes up to 2/3rd

[David]

Yes, the departing member will report a capital gain on his 1040. I need to zero out the departing member's $12K negative capital account by crediting the member's account on the books. Where does the offsetting credit get recorded on the books and in the tax return?

Thanks.

[David]

Whoops! In the previous post I meant to ask where does the offsetting debit get recorded on the books and in the tax return?

Thanks.

[mircpa]

Don't you think partnership should record 12K as capital loss & 2/3rd partner's K1 would reflect this partnership interest loss.

[grandmabee]

This is where clients should contact us before doing anything.  This would have been so simple if one member just bought out the other outside of the partnership.

[DANRVAN]

There are two possible ways the termination of the partner's interest can be treated: as a purchase by one or more remaining partner or as a liquidation of the partner's interest.  In either case a section 754 election should be  considered.

If treated as a purchase, the outgoing partner basically sells his interest to one or more remaining partner.

Under the liquidation method the partnerships buys back the outgoing partner's interest.

In this situation, it sounds like a partner put up $18,000 to purchase the interest of the out going partner so you should consider a 754 election and record accordingly.

[DANRVAN]

On 2/22/2019 at 11:07 AM, David said:

Whoops! In the previous post I meant to ask where does the offsetting debit get recorded on the books and in the tax return?

Thanks.

David, it looks to me like this situation is a case where partner A buys out partner C based on the fact that A put up the money in order to obtain a 2/3 partnership interest. If that is the case, the transaction should be recorded as purchase from partner to partner rather than  a liquidation of partner C's interest by the partnership and the two remaining partners would have 50/50 ownership.

Although the transaction should have taken place outside the partnership, the partnership in effect acted as a facilitator by taking the money from A and passing it to to C, the financial position of the company did not change as a result.

Record the $18,000 check from A as a credit to an account such as "Payable to C from sale of Capital to A".  Then debit same account when company writes check to C which will zero that account out.  Final entry will debit Capital-C and credit Capital-A for $6,000 which will be reported as distribution on K-1.

If on the other hand, the partnership was liquidating the interest of partner C,  you would need to allocate the $18,000 between 736(a) and 736(b) payments.  Basically, 736(b) payments are made for the fmv of the partnership interest and are recorded as a distribution by the partnership and reported as capital gain by partner of amount in excess of basis. The 736(a) payments are usually treated as guaranteed payments taxable as SE to partner. 

In professional firms there is usually an agreement which spells out how the payments will be allocated to the retiring partner between 736(a) and 736(b) payments.

[DANRVAN]

On 2/22/2019 at 10:07 PM, mircpa said:

Don't you think partnership should record 12K as capital loss & 2/3rd partner's K1 would reflect this partnership interest loss.

In a liquidation of partner interest,  partnership would record payments as non deductible distributions or as guaranteed payments as agreed upon.  Partnership would not incur a loss.

 

[ILLMAS]

Zionks, after reading the original post, I have a client that went into business with A & B, A & B loan/invested $30K into my clients business.  My client made A & B each 25% owners, fast forward to 2019, my client is thinking of buying A & B out, don;t know for how much, but A & B's basis is -130K.  Once A & B knows they would have to pay taxes on the negative basis, they might not want to sell.

[David]

Thanks for helping with this.