Conversions of SMLLCs to LLCs and vice versa.

• Author: Lenz, Thomas C.
• Position: Single member limited liability companies

In January 1999, the IRS issued Rev. Ruls. 99-5 and 99-6, outlining the Federal income tax consequences of partnership entity reclassifications: Rev. Rul. 99-5 explains the results when a single-member limited liability company (SMLLC) becomes a two-member entity; Rev. Rul. 99-6 explains the consequences if one person purchases all the ownership interests in a limited liability company (LLC) classified as a partnership. Among other things, the rulings demonstrate how different tax consequences may result, depending on how transactions are structured.

New Member Purchased Part of SMLLC Interest

Rev. Rul. 99-5 describes what happens when a new member purchases a 50% ownership interest from an SMLLC. The new member is treated as purchasing 50% of the LLC's assets directly from the existing owner, followed immediately by a contribution of assets to a new partnership in exchange for ownership interests in that partnership.

The selling member will have gain or loss from the deemed sale of 50% of the assets. The new member's tax basis in the LLC is equal to the purchase price, while the former member's tax basis is equal to his basis in the 50% of assets he "contributed" to the partnership. The holding period for each member will differ: The former owner will have a tacked-on holding period, which will include the period of time he held the original assets (the ruling does not address how to handle multiple holding periods); the new member will begin his holding period the day after he purchases his interest.

The basis in the partnership assets will carry over from the property's basis in the owner's hands. In addition, the holding period of the LLC assets will include each member's holding period for such assets. This means each asset in the LLC will have a split holding period.

New Member Admitted to SMLLC

Rev. Rul. 99-5 also describes what happens when a new member is admitted as a 50% owner to an SMLLC for cash and the co-owners continue the LLC. Similar to the first situation, the LLC is converted from a disregarded entity to a partnership at the time of the contribution. The new member's contribution is treated as a contribution to a partnership in exchange for an ownership interest. The existing owner is treated as contributing all SMLLC assets to a new partnership in exchange for a partnership interest. The key difference between the two situations outlined in Rev. Rul. 99-5 is that in the first...