Liquidation of an LLC.

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

[ILLUSTRATION OMITTED]

A host of issues surround a member's receipt of a distribution in complete liquidation of the member's interest in an LLC classified as a partnership.

Upon complete liquidation of a limited liability company (LLC) classified as a partnership, a distributee member generally does not recognize gain unless the cash and the fair market value (FMV) of marketable securities distributed exceed the outside basis in his or her LLC interest (Secs. 731(a) and (c)(2)). (Note that this column addresses the complete liquidation of an LLC as opposed to liquidation payments made to a retiring member or a deceased member's successor in interest.) Likewise, no gain or loss is recognized by the LLC on a liquidating distribution (Sec. 731(b)).

These general rules regarding gain or loss on liquidation are a major reason for formation as an LLC rather than as a corporation. While both entities provide owners with protection from liability, a corporation and its shareholders generally must both recognize gain or loss on liquidation. Upon distribution of property in complete liquidation, the corporation is treated as if the distributed property is sold at FMV to the distributee (Sec. 336(a)). The distributee shareholder generally must recognize gain or loss equal to the difference between the FMV of the property received and his or her basis in the corporations stock (Sec. 331(a)).

Tax Effects of LLC Liquidation Possibility of Gain or Loss Recognition

Gain is recognized by a member in an LLC classified as a partnership on the receipt of a liquidating distribution to the extent money is distributed in excess of the distributee member's basis in his or her LLC interest (see Sec. 731(a)

(1)). Gain is also recognized under Sec. 731(a)(1) when a member receives marketable securities that are treated as money in excess of the member's basis in his or her LLC interest (see Sec. 731(c)

(2)). In addition, gain may be recognized if (1) distributions of Sec. 751 hot assets (unrealized receivables and substantially appreciated inventory) are not proportionate (see Sec. 751(b)); (2) property that had an FMV different from basis on the date of contribution is distributed to a member other than the contributing member within seven years of contribution (see Sec. 704(c)(1)(B)); (3) the distribution is within seven years after a contribution of appreciated property (see Sec. 737); or (4) the distribution is part of a disguised sale (see Sec. 707(a)(2)).

A loss may be recognized upon a distribution in liquidation of a member's interest if no property other than cash, unrealized receivables, and inventory is received. The loss recognized is the excess of the member's adjusted basis in the LLC over the sum of the cash distributed and the member's basis in the unrealized receivables and inventory received (Sec. 731(a)(2)).

Example 1. Nontaxable liquidating distribution of cash andproperty: Z LLC is liquidating. Z is classified as a partnership. R's basis in his Z interest is $52,000. He has never contributed property other than cash to the LLC. To liquidate his interest, Z distributes to R $15,000 cash plus real property with a $50,000 FMV. Z's adjusted basis in the real property is $30,000. The LLC has no unrealized receivables or appreciated inventory, so Sec. 751 does not apply. The LLC acquired the real property by purchase.

R recognizes no gain or loss on the liquidation. R first reduces his $52,000 outside basis by the $15,000 cash distribution. His...