Partnerships/disregarded entity conversions.

• Author: Noles, Susana
• Position: Taxation

Rev. Rul. 99-5 and 99-6 address, respectively, the Federal income tax consequences of converting a disregarded entity to a partnership and of converting a partnership to a disregarded entity. The factual situations presented are relatively straightforward, assuming that neither the entities nor the assets in them are liable for any debt and that all assets held by the entities are capital assets or property described in Sec. 1231. Thus, the rulings provide guidance on the general methodology to be applied in analyzing a conversion without addressing the treatment to the partners in more complex conversion transactions.

Conversion from SMLLC to Partnership

Rev. Rul. 99-5 describes the tax consequences, under two factual situations, in which a single-member limited liability company (SMLLC) disregarded as an company separate from its owner under Regs. Sec. 301.7701-3 converts into an entity with more than one owner classified as a partnership for Federal tax purposes.

Under the first scenario, an SMLLC is formed and disregarded as an entity apart from its owner, A. Later, B, an entity unrelated to A, purchases 50% of A's interest in the LLC for $5,000. A does not contribute the money received in exchange for its interest to the LLC. Both A and B continue to operate the LLC's trade or business as joint owners.

The sale by A of a 50% interest in the first scenario in Rev. Rul. 99-5 is treated as a sale of 50% of A's interest in each of the SMLLC's assets. As a result, A recognizes gain or loss to the extent the sale price exceeds or is less than A's basis in each of the assets deemed sold. A and B are then deemed to contribute the assets in a nontaxable Sec. 721 transaction to the new partnership in exchange for ownership interests.

A's basis in its ownership interest in the partnership will be the same as its adjusted basis in the assets deemed contributed. B's basis in its ownership interest will be the same as the purchase price of the assets it contributes ($5,000). The partnership's basis in the assets will be equal to the adjusted bases of the assets in A's and B's hands.

Rev. Rul. 99-5 also provides that the holding period of A's interest will include the holding period of the assets to A prior to the conversion; B's holding period will begin on the date following the date of purchase of the assets. The partnership's holding period in the contributed assets carries over from the contributors.

The second scenario also begins with the...