7.3 Tax Free Formation

• Library: Limited Liability Companies in Virginia (Virginia CLE) (2017 Ed.)

7.3 TAX FREE FORMATION

7.301 In General. Generally, the formation of a partnership or LLC is income tax free. A trap exists for the unwary planner, however, because gain will be recognized if appreciated securities are transferred to a partnership or LLC under I.R.C. § 721(b) and the partnership or LLC is treated as an investment company as described in I.R.C. § 351.

7.302 Investment Company. Under I.R.C. § 351(e)(1), a transfer of property will be considered a transfer to an investment company if the transfer results, directly or indirectly, in diversification of the transferors' interests and the transferee is a regulated investment company, a real estate investment trust, or a corporation (or partnership or LLC in the case of transfers to those entities) more than 80 percent of the value of whose assets are held for investment and are stock, securities, or other investments or interests in regulated investment companies or real estate investment trusts. ¹⁴ Section 1002(a) of the Taxpayer Relief Act of 1997 amended I.R.C. § 351(e)(1) to include cash and certain other types of investments in determining whether gain will be recognized on the formation of the LLC. Before then, only marketable stock or securities would be considered in determining whether an entity would be treated as an investment...