Determining if a technical termination occurs.

• Author: Ellentuck, Albert B.
• Position: Of a partnership

For tax purposes, the termination of a partnership or an LLC classified as a partnership (collectively referred to here as an LLC) is triggered if there is a sale or exchange of 50% or more of the total interests in the LLC's capital and profits within a 12-month period (Sec. 708(b)(1)(B)). This type of termination is frequently referred to as a "technical termination" since it is seldom the members' intent to actually terminate the LLC. When an LLC terminates under these provisions, its assets are considered contributed tax free to a new LLC (under Sec. 721), and the interests in the new LLC are then deemed distributed to the members of the old LLC (Regs. Sec. 1.708-1(b)(4)).

Under these rules, there is no deemed distribution of "old" LLC assets to the members and no deemed recontribution of the assets to the "new" LLC. As a result, the "new" LLC's basis in its assets is identical to the basis of the assets in the "old" LLC.

The LLC's tax year closes on the date of the termination and the creation of a "new" LLC for federal tax purposes. Consequently, the new LLC must make new tax elections and adopt new tax accounting methods. For example, the "new" LLC must make a Sec. 754 election to cover post-termination exchanges of LLC interests. However, any member-specific basis adjustments resulting from Sec. 754 elections made prior to the technical termination carry over from the "old" LLC to the "new" LLC (Regs. Sec. 1.743-1(d)). A member with a special basis adjustment in property held by an LLC that terminates under the technical termination rules will continue to have the same special basis adjustment with respect to property deemed contributed by the terminated LLC to the new LLC, regardless of whether the new LLC makes a Sec. 754 election.

In addition, if an LLC is terminated by the sale or exchange of an interest, a Sec. 754 election made by the terminated LLC that is in effect for the tax year of the terminated LLC in which the sale occurs, applies to the incoming member (Regs. Sec. 1.708-1(b)(5)).

To determine if an LLC terminates, the practitioner must determine whether an LLC interest was disposed of in a "sale or exchange" as defined in the Sec. 708 regulations. If so, did the sale or exchange result in 50% or more of the total interests in LLC capital and profits being sold or exchanged during a consecutive 12-month period?

Sale or Exchange Under the Technical Termination Rules

The regulations do not define a sale or exchange for...