LLC distributions of contributed property.

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

A LIMITED LIABILITY COMPANY (LLC) member who makes a contribution to the LLC of property with a fair market value (FMV) different from its basis may be required to recognize gain or loss upon a subsequent distribution of the contributed property to another member. Under Sec. 704(c)(1)(B), a distribution of contributed appreciated or depreciated property within seven years of the date of contribution requires the contributing member to recognize remaining precontribution gain or loss on the date of such distribution.

The amount and character of the gain or loss is determined as if the LLC had sold the property to the distributee member for its FMV on the date of distribution. The pre-contribution gain or loss recognized is the difference between the FMV and tax basis of the property on the date of contribution, reduced by any portion of that amount already taken into income by the contributing member before the date of distribution under the Sec. 704(c) rules.

An installment obligation received by an LLC or partnership and property acquired pursuant to a contributed contract are treated as Sec. 704(c) property under the rules for distributions of contributed property to the extent that the installment obligation or the acquired property is Sec. 704(c) property under the substituted basis rules of Regs. Sec. 1.704-3(a)(8). As a result, if the installment obligation or property acquired pursuant to a contributed contract is distributed by an LLC or partnership to a member or partner other than the contributing member or partner within seven years of the contribution, the contributing member or partner may recognize gain or loss under Sec. 704(c)(1)(B) (Regs. Secs. 1.704-3(a)(8) and 1.704-4(d)).

It appears the contributor must recognize gain or loss as if he sold the contributed property and realized the gain or loss directly. As a consequence, the contributor recognizes the gain or loss for the year that includes the date of the triggering distribution, rather than the year that includes the last day of the LLC's tax year in which it makes the distribution.

Distributions of Built-In Loss Property

While Sec. 704(c)(1)(B) requires the recognition of any built-in gain or loss, built-in loss triggered by a distribution of property contributed by a member who holds more than a 50% interest in the LLC is disallowed due to the application of Sec. 707(b)(1)(A). Though not specifically mentioned in the Sec. 704 regulations, this issue is addressed in the preamble to the regulations (T.D. 8642).

Required Basis Adjustments

If a member recognizes gain or loss under the Sec. 704(c)(1)(B) rules, the distributee member's basis in the distributed property is the LLC's basis in the property immediately...