Liquidation of an LLC member interest.

• Author: Wright, Carol
• Position: Limited liability companies

The dramatic increase in the past few years of limited liability companies (LLCs) treated as partnerships as the entity of choice has lead to an increase in liquidations of member interests.

At first glance, the rules for a complete liquidation of a partner's interest appear simple. For example, because a membership interest is a capital asset of the member, a sale of the capital asset would be expected to result in a gain or loss equal to the difference between the sales proceeds and the basis. However, this simple model frequently is not correct. In fact, no gain is recognized in a distribution of property and cash to a partner, even in a liquidation of interest, unless the cash distributed exceeds the partnership basis. Loss is never recognized by a partner in liquidation unless the property distributed consists entirely of cash, unrealized receivables, inventory or a combination of the three. Property received by the liquidated member has a basis equal to the basis in the partnership interest, reduced by cash received in the liquidation.

The holding period for the distributed property will generally begin when the partnership interest was acquired. If the membership interest was originally received in exchange for a contribution of property, the holding period would have begun when the property was acquired by the contributor rather than when the partnership interest was received. A contribution of inventory would be an exception to this holding-period tacking. Multiple contributions of cash or other property to the partnership will result in multiple holding periods for the distributed assets. Generally, distributions do not trigger gain or loss to the partnership, regardless of whether the distribution is cash, property or a combination of both.

Complicating Factors

Further investigation of Subchapter K dissolves the facade of simplicity, as numerous parts of Subchapter K can come into play on a liquidation of a partner's interest. Sec. 751 requires recognition of gain from "hot assets" as ordinary income. Sec. 704(c) gain on contributed property may need to be recognized under Sec. 737. If the liquidated partner makes a contribution prior to the liquidation and receives property in liquidation, Sec. 707 may recast the liquidation as a disguised sale. A Sec. 754 election to allow for a basis adjustment of partnership assets under Sec. 734 may be necessary. The new rules under Sec. 734 may require a mandatory "step-down" even if a Sec...