Selling LLC with installment payments

[stevemfreeman]

I am selling my 50% share in an LLC. The buyer is paying for the share in equal installments over 5 years. Do I have to claim capital gains on the entire sale this year or only on the payment I receive this year and then the same for the next 4 years.

[Anonymous_]

In terms of the type of (income) gains, that would be dependent upon the nature of the assets. 

However, I will page @Rick19744 and, hopefully, he will respond shortly with a comprehensive answer.

In the interim, below are a couple of threads that may be of interest to you.

https://ttlc.intuit.com/community/business-taxes/discussion/installment-sale-of-membership-interest-...

https://ttlc.intuit.com/community/business-taxes/discussion/re-sale-of-llc-interest/01/2033099#M6749...

[stevemfreeman]

Thanks. I will wait for his input. In the meantime: All of the assets are normal assets, no 751 property. All of the assets are fully depreciated so my tax basis in the llc is 0. I have had the llc for 16 years so everything is long term. Is there anything else he might want to know?

[Anonymous_]

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@stevemfreeman wrote:

Is there anything else he might want to know?

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The lack of hot assets simplifies the scenario to an extent, but the seller (and buyer) may be best advised to consider seeking professional guidance, regardless.

[Rick19744 · Accepted solution]

The sale of an LLC interest is treated as if the seller sold their portion of the underlying assets; look through.

Without having the ability to look at the actual financials, I can only provide some higher level thoughts:

• Not sure what you mean when you say "all of the assets are normal assets - no section 751 property".
• Any asset that is depreciable falls into the section 751 category; the recapture of depreciation.
• If all assets are fully depreciated, then you will most certainly have depreciation recapture AND section 751 will apply.  The tax provisions treat the sale as if you sold the underlying assets at FMV.  As a result, I would imagine that the seller (you) would most likely have depreciation recapture (hence section 751).
• Is the LLC overall method of accounting accrual or cash basis?  If cash basis, then section 751 will apply to any unrealized receivables (your share).  This would of course be netted against your share of any payables.  Once again, this only applies if the LLC was on the cash basis of accounting.
• Keep in mind that section 751 is really just a recharacterization of the gain from capital gain to ordinary income; doesn't change the overall gain or loss.
• Also keep in mind that any depreciation recapture (as a result of section 751) will be taxed in the year of sale.  This takes some off guard if proper planning wasn't done as the seller needs to make sure that they receive sufficient cash in the year of sale to cover any ordinary income that is taxed in the year of sale; no installment sale allowed on this component.
• The seller also needs to run the numbers to make sure they actually benefit from the installment sale provisions after the provisions of section 751 are applied.  Example:  the overall gain is $15,000 with section 751 of $17,000 (seller share of depreciation recapture).  In this case, all $17,000 of section 751 is recognized in the year of sale and you then have a $2,000 long term capital loss.  No installment sale benefit here.  
• A final point, who is acquiring your 50% ownership?
  • There is no mention of ownership structure other than your 50%.
  • Revenue Ruling 99-6 may come into play if the LLC becomes a disregarded entity as a result of your sale of 50%.  This wouldn't impact you, but would impact the buyer if the facts fall within the provisions of this revenue ruling.
• Depending on the $$ involved, it may be in your best interest to consult with a tax professional.  Partnership tax provisions are complicated.

[stevemfreeman]

Sorry, confused. Yes I will have 751. There are only 3 assets in the LLC. All 3 purchased 15 years ago for $30,000 each and fully depreciated over the following 15 years. LLC is remaining active as other member (50%) is retaining his share and purchaser will have my 50%. There have been no improvements or changes to the assets to change my basis.  Current market value for the 3 assets is $70000 each. So I assume I will have capital gains of $105,000 which is the purchase price. I am allowing the purchaser to pay the $105,000 out over 5 years with equal yearly installments. Question is whether I have to declare $105,000 of capital gains the year of sale or can declare $21,000 in capital gains that year and each year for the next 4 years. Is there any other information you would need. It is a very simple LLC.

[Rick19744 · Accepted solution]

Based on the additional limited facts:

• You didn't respond to the method of accounting question as this could have some impact.
• I would also be surprised if your tax basis is exactly zero, but it is possible if all profits were distributed.  Have you been maintaining your tax basis?  This figure is key as it impacts your overall gain on the sale of your interest.
• Since there are two original partners, your share of Section 751 for the assets will be $45,000 (half of the $90,000 in depreciation taken).
• You need to look at the form 6252 and I would recommend manually completing one to make sure TT arrives at the same end result.
• When completing the form 6252, you will note line 9 is where your share of depreciation will be entered.
• As a result of the additional facts, you will recognize $45,000 in ordinary income in the year of sale.
• You will then have $60,000 in capital gain spread over the installment period including some in the initial year.  This will be based on the computation in Part II of the form 6252.
• As you can see, "a very simple LLC" does not equate to a simple tax result when dealing with partnerships.

[stevemfreeman]

We are operating on a cash accounting system.

We have always distributed all of the profits and have made no capital contributions to the LLC.

Since I will have $45K in ordinary income from the recovered depreciation am I correct that the initial $12K purchase payment that first year will not be counted as capital gains since I am already taking the $45K as ordinary income. 

Will I continue to not have capital gains each year until the payments exceed the $45K I will be taking as ordinary income?

Thanks again for all your time. 

[Rick19744]

2nd follow-up:

• If you are on the cash method of accounting, then you will have some additional Section 751 to the extent of any sales that have occurred and the cash has not been received.  You will net this with any payables that have not been paid.
• Example:  If you have sales of $10,000 where you have not received the cash and $2,000 of payables that the LLC has not paid, your 50% of the net figure is $4,000 (50% of $8,000).
• This $4,000 is also Section 751 property and ordinary income to you.
• So now, based on your facts you will have $49,000 in ordinary income and $56,000 in capital gain (this totals your $105,000 gain that you indicate you have).
• As stated previously, you need to manually prepare the form 6252 to determine your gain that needs to be recognized in year one (the year of sale).  This will be a combination of ordinary gain and capital gain.
• The $12,000 that you received will be used to pay the tax in the year of sale and each year thereafter.  See last bullet.
• You will also need to complete form 4797 for the ordinary income component.
• As you can see, nothing is simple when it comes to partnership tax.
• I strongly recommend you meet with a tax professional who can provide assistance in order to determine the correct gain, how to properly report it and in the end, result in the correct tax for 2020.  This cost will certainly provide you with the benefit of getting it correct in 2020 and help you in the following years.
• As you can see, the section 751 component can catch individuals off guard.  In your case, if you are in the 25% tax bracket, $49,000 x 25% = $12,250.  This tax will take all of the $12,000 received in year one; which does not include the tax on the capital gain component in year 1.
• Or is the $12,000 that you mention really $21,000 ($105,000 / 5 = $21,000).  In that case, you will be okay.