Contributing intangible property to an LLC.

• Author: Ellentuck, Albert B.
• Position: Limited liability company

SEC. 721 GENERALLY PROVIDES THAT A member's transfer of property to a limited liability company (LLC) taxed as a partnership does not result in income or loss to the member or the LLC. The LLC steps into the shoes of the contributing member with respect to the holding period and adjusted tax basis of the contributed property (Secs. 1223 and 723). This general nonrecognition rule applies both to contributions made upon the formation of the LLC and to subsequent contributions by new or existing members.

However, the nonrecognition rule applies only to contributions of property. While there usually is little difficulty in determining whether a contribution consists of property, questions can arise when a contribution could be characterized as property created by a person's services or services that create property for the LLC's benefit. This issue also arises if a member's capital account is credited with an amount that clearly exceeds the fair market value (FMV) of the contributed property. In these situations, the adverse consequences of a misstep can be significant.

What Constitutes Property?

In most instances, determining whether a member's contribution is property is a simple task. Money, fee title to real estate, and ownership of equipment are examples of contributions that clearly constitute property. When the property was created by the personal efforts of a member, however, there may be a question of whether the interest was received for the product (property) or the effort (services).

There is no requirement that the contributed property be tangible (see, e.g., Rev. Ru!. 71-564 and Ambrose, T.C. Memo. 19.56-125). Contract rights, goodwill, technical knowledge, and trade secrets all constitute property eligible for nonrecognition treatment. Also, a federal appeals court overturned a district court ruling that a letter of intent could constitute property only if it had value and was legally enforceable (Stafford, 727 F.2d 1043 (11th Cir. 1984)). The appeals court disagreed, determining that enforceability was not an essential condition of property status. The court analogized the letter of intent to goodwill, which is considered to be property even though it is unenforceable. For that reason, although it was not binding, the letter of intent constituted property. The property had been created by the partner's efforts, for his own account, and the partner owned the property before he contributed it to the partnership. As a result, the...