Contributions of property to an LLC.

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

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THE TAX TREATMENT OF A CONTRIBUTION to a limited liability company (LLC) depends on whether the LLC is taxed as a partnership, a disregarded entity, or a corporation. A contribution to an LLC taxed as a corporation is subject to the rules governing corporations. Generally, the contributions are nontaxable if the transfer of cash and property to the corporation is solely for stock (other than nonqualified preferred stock) and immediately after the exchange the transferors control the corporation. A contribution to an LLC taxed as a disregarded entity has no tax consequences because the entity is not considered an entity separate from its owner. Contributions to an LLC taxed as a partnership are governed by the partnership rules. These rules will be the subject of the remainder of this discussion.

Note: An LLC taxed as a corporation with different classes of membership could be deemed to have nonqualified preferred stock, even if the membership units are not called that anywhere in the LLC agreement.

General Nonrecognition Rule

Generally, Sec. 721 provides that a member's transfer of property to an 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.

Example 1: A, B, and C form ABe LLC, which provides accounting services and is classified as a partnership. Each member practiced accounting as a sole proprietor prior to the formation of ABe. A contributes $10,000 cash. B contributes $5,000 cash and a tax library with a $5,000 FMV and a $3,000 tax basis. C contributes $1,000 cash and computer equipment with a $9,000 FMV and an $8,000 tax basis.

A, B, and C recognize no gain or loss on the contributions made to the new LLC. Likewise, the LLC recognizes no gain or loss on receipt of the contributions. Under Sec. 723, the LLC's basis in the contributed assets is the same as each contributing member's basis in the assets prior to the contribution. Therefore, ABC has a tax basis balance sheet reflecting $16,000 cash, a tax library with a $3,000 tax basis, and computer equipment with an $8,000 tax basis.

Example 2: Assume now that in the year after formation, A contributes an...