Gains & losses: IRS rules on consequences of sale of LLC interest treated as sale of real estate.

• Author: Fisher, Mark
• Position: Limited liability company

The IRS has ruled that an individual's sale of a limited liability company (LLC) interest, treated as a sale of an undivided interest in the underlying real property owned by the LLC, is subject to neither the Sec. 453(e) related-party rules nor the Sec. 453(g) installment method disallowance rule. However, the individual must recognize all unrecaptured Sec. 1250 gain to the extent of Sec. 1231 gain in each tax year attributable to the sale (Letter Ruling 200937007).

Facts

The taxpayer for whom the letter ruling was issued is an individual who owns improved residential and commercial real estate but has not sold any real estate in several years. A trust was formed to invest in real estate and elected to be treated as a corporation for federal income tax purposes. The trust does not currently have any assets. A licensed realtor owns all the beneficial interest of the trust and serves as the trustee.

The trustee and the taxpayer are not related by blood or legally, but each owns a 50% interest in three partnerships: partnerships 1, 2, and 3. The trustee, the taxpayer, and individuals 1 and 2 each own 25% of partnership 4. The trustee and individual 1 are brothers.

Partnership 4 is an LLC and a disregarded entity under Sec. 761(a) for purposes of subchapter K. Partnership 4 owns one commercial real estate building from which it receives rental income. Partnership 4 depreciates the building using the straight-line method.

The taxpayer intends to sell his 25% interest in partnership 4 to the trust, reporting the gain using the installment method under Sec. 453. The trust will issue a promissory note, make monthly interest payments, and make a balloon payment for the principal at the end of the note term. The taxpayer will retain a security interest in the assets of the trust, including the membership shares of partnership 4. The trust is not and will not become a creditor of the taxpayer. The sale will be treated for federal income tax purposes as a sale of the taxpayer's 25% interest in the commercial building. The trust may sell its 25% interest in partnership 4 or the undivided interest in the real property within two years after the installment purchase.

Issue 1--Related Parties

Under Sec. 453(e), if a taxpayer (the first seller) sells property to a related person and reports the gain under the installment method, and the related buyer later sells the property in a second disposition before the first seller reports all gain from the first...