Purchased partner's 50% ownership of an LLC on November 1

[Stangyz]

Hello.

I purchased my partner's half of our CrossFit gym on November 1. I created a new LLC and I am using TurboTax business to file for 2019.

TurboTax directed that 2019 will be the final tax filing for the partnership LLC and TurboTax indicates that we have to dispose of all assets of the partnership.

Do I show everything as "sold" since I am sole proprietor now?

Does the sale of all assets have to equal the amount I paid my partner?

[RobertG]

No, you don't show the assets as sold, since they were not sold, they were distributed to a member of the LLC. You. This is also a form of disposition.

Distributions of property to a member in an LLC are generally tax-free.

The LLC's basis in the assets becomes your basis in the assets.

[Stangyz]

Thank you for your response!

[Rick19744]

Hang on here.

There are a number of missing facts:

• You indicate that you bought out your partner's 50%.  Were there only two partners?
• You then indicate that you created a "new LLC".  Is this new LLC a multi-member LLC or are you the sole owner?
• Have you been maintaining your basis in the LLC?  This is important to understand.
• Your former partner most likely has ordinary income to report on the sale which would be related to the sale of depreciable property.  Are either of you aware of this?

[Stangyz]

• Yes, we were the only two partners.
• I guess I didn't actually create a new LLC, i just renamed it through the state of Texas. I am not the sole proprietor.
• "Have you been maintaining your basis in the LLC? This is important to understand."
  • I don't understand what maintaining our basis in the LLC means.
• Your former partner most likely has ordinary income to report on the sale which would be related to the sale of depreciable property.  Are either of you aware of this?
  
  • I don't understand this either. I understand the LLC owned depreciable property and I paid him to take 100% ownership.

I appreciate your time and information. All of this is very new and very confusing for me. I thought it would be easy with TurboTax but I feel that i am in over my head.

[Stangyz]

I want to also add that we signed the paperwork and i handed him a check on November 1, 2019.

Does this mean the partnership return has all financial information for January through October or for the entire year? I entered all financial information for Jan through October in TurboTax business and assumed i would include the Nov and December financials in my personal return since i am now sole proprietor.

[Stangyz]

Also, in my reply above it stated "I am not the sole proprietor" but that was a typo. I AM THE SOLE PROPRIETOR.

[Carl]

This is perfectly doable with TurboTax. But you "REALLY" have to know what you're doing.

Basically, the partnership will be filing it's "final" 1065 return and will be closed/dissolved permanently and forever. You can "NOT" reuse the EIN for that partnership either. It's retired permanently and forever. Several criteria have to be met for this partnership to "truly" be dissolved.

- If the partnership carried an inventory, then the EOY Inventory balance *MUST* be zero.

- If the partnership has any assets, then all assets "must" be disposed of by the partnership. Generally for your situation, they would be shown as distributed to any of the departing partners. (Yes, **YOU*** are also a departing partner from this partnership, since a partnership can not exist with only one member.)

- If any vehicle use was claimed/reported by the partnership on the 1065, even if that use was less than 100% business use, then you must show disposition of the vehicle. Be it sold, distributed, given away, destroyed, casualty damage, whatever.

Now on your 1040 SCH C here's some things that are important.

 - The start date of the business will be the date the "the business" (meaning "the partnership") was open for business.  Doesn't matter that it was a prior year either.

 - The "in service" date for all assets will be the original date that asset was placed in service in the partnership. Doesn't matter that it was a prior year either.

If inventory is involved, then the BOY Inventory balance *MUST* be zero. There are no exceptions.

Now here's a question I can't answer.

 - Who gets what part of prior depreciation taken in the partnership already, on distributed assets? Since prior depreciation was split between the partner's each year, who gets what amount? How is it accounted for? My "guess" is that if you only get half the depreciation, then you will claim only 50% business use on your SCH C for the period of time that asset was in the partnership. Then you claim 100% business use starting one day "after" the partnership dissolved. But this is just a guess.

[Rick19744 · Accepted solution]

Ok.  Responses are in line with what I thought, just don't want to assume too much here.

1. What has happened is that your business went from a multi-member LLC to a single member LLC (SMLLC) when you bought out your partner.
2. You have a final partnership return that WAS due January 15th.  Attempting to file a late extension will do you no good.  Just get the form 1065 filed as quickly as possible.  You will most likely receive a notice from the IRS regarding late filing along with some penalty.  Respond that you now realize the return was due sooner as a result of the partnership termination, however, all member's have received their K-1's and there was no intent to avoid or evade the tax laws.  It was a simple misunderstanding.  Any correspondence with the IRS should be sent certified mail return receipt requested.
3. Your situation is covered by Revenue Ruling 99-6, of which I have attached a link.  Your facts are situation 1 in the revenue ruling.  Read through this a couple of times to make sure you understand the mechanics of what is going on post LLC termination.  You will note that depending on the assets held by the LLC, you could have a bifurcated basis in each asset post termination.
4. https://www.irs.gov/pub/irs-drop/rr-99-6.pdf
5. As a member in an LLC taxed as a partnership, you need to maintain a basis schedule.  This is your investment in the LLC.  Your basis begins with your capital contribution and is updated annually for the applicable lines on your K-1.  Your basis is very important as it determines whether losses are currently allowable and also your gain or loss upon sale.  Attached is a link to the instructions for the 1065 K-1.  Page 3 has a discussion of how your basis is adjusted annually.
6. https://www.irs.gov/pub/irs-pdf/i1065sk1.pdf
7. You now need to determine the allocation of the purchase price you paid for the 50% of the business.  Since an LLC taxed as a partnership is a pass-through entity, you need to allocate that purchase price to the various assets.  
8. Then these assets are distributed out to you.  Once again you now have to allocate a basis to the assets, however, the total allocated to the assets can't exceed your basis in the LLC.  Yes this is somewhat confusing, but it is the way it needs to be done.  There are specific rules in the regulations that deal with this based on various facts.  You may want to consult with a tax professional to get this right.
9. Finally, your partner needs to determine their overall gain or loss on the sale of their interest.  Additionally, if you have what is called "hot assets" (Section 751 property) some of the gain may need to be reclassified as ordinary.  The hot assets would be depreciable property (depreciation recapture), receivables if you were cash basis and inventory.  Once again, this can be tricky and the help of a tax consult would be beneficial.  The overall gain or loss does not change, it is just the classification (characterization) most likely will be changed.  Example:  Overall gain of $10,000.  Section 751 property gain $5,000.  Here the partner will have $5,000 of ordinary income and $5,000 of capital gain.
10. Your LLC just continues on; no longer a multi-member LLC, but just a SMLLC reported on your Sch C
11. May be overwhelming, but this is the world of partnership tax.

[Stangyz]

Thank you!

I will get it filed as soon as possible but I still feel so overwhelmed with all of this.

I'm certain i will have to ask more questions.

[Stangyz]

So will i file 1 return for the partnership for financials from January 1 through the sale date of November 1 and a second return for November and December as a sole proprietor?

[Anonymous]

In this scenario, if you know that all depreciable assets need to be distributed to a member or members on the last day of the short year (when the partnership became a SMLLC), does anyone know HOW to accomplish the asset disposal in TurboTax Business 2019?  Do you just dispose of the assets using the "SOLD" option and report proceeds equal to adjusted basis on the final date?  There is no option to dispose of assets by distribution to partners in TurboTax Business, that I can find at least.

Help!

[Rick19744]

@Stangyz correct.

Make sure you indicate the the form 1065 is final.

[nicholas13]

Thanks @Rick19744 

Very helpful.

I am in a similar situation as the OP and hoping you might be able to help:

Multi member LLC, taxed as a partnership, where I am buying out my partner, and continuing the business as a SMLLC.

Two related questions:

how to dispose of assets? These assets are obviously coming with me and the SMLLC, but in TT Business in while creating the final 1065, it is requiring me to dispose of all assets.

If I mark them as sold that figure would end up on the books of the about -to-be dissolved-partnership, which seems counter intuitive since I am paying my former partner, not the partnership, for the business, including the assets (FYI - all purchased assets have taken the full section 179 in the year they were purchased).

If I mark them as "disposed of" does that create issues elsewhere?

Second - where do we report the sale of membership interest and is that even necessary if there are no hot assets?

Thanks

[Rick19744]

These type of situations / transactions can be difficult and may need a tax professional to help get it right:

• Your transaction is described in and provided guidance in Revenue Ruling 99-6 situation 1; going from a multi-member LLC to a single member LLC.   
• For TT you should show the assets as "sold", but you will need to adjust the sales price so there is no gain or loss reflected.
• You will need to save and print out the depreciation detail as you may need this.
• As you noted, you will end up will all the assets.  Your basis in these assets will now be bifurcated
  • 1/2 of each asset "may" remain the same which is your portion of each asset (I say may change as noted below in sub bullet 3 below).
  • 1/2 of each asset will now take a new basis equal to your purchase price paid for these assets.  
  • Additionally, your basis in your 1/2 of the assets may now take a substituted basis as when these assets get distributed out to you the basis in these assets can't exceed your basis in your LLC interest.  There are specific rules / guidance in how this allocation process works.
  • The basis of the assets for you is determined as if all the assets were deemed liquidated to both you and your partner, and then you purchased the assets from this individual.  Once again, this hypothetical deemed liquidation is only for determining your basis in the assets.
• You will also need to inform the selling member of their share of Section 751 property (hot assets).  This will be their share of depreciation recapture.  They will need to report this as ordinary gain.  Determining the selling member's gain needs to be worked through as well, however, that is their issue.