After 2 member LLC converted business assets to personal use in 2017, how does 1065 (which remains in existence) report conversion of business assets to personal use?

[captainl51]

LLC (husband and wife) will remain in existence in future for liability reasons although no business is conducted.  I think but would like to confirm that a sale of exchange of business assets that were converted to personal use is reported at FMV and gain, if any, would be subject to ordinary income treatment due to depreciation recapture.  

[Rick19744]

Are you filing a final form 1065 for 2017?

[captainl51]

Not sure.  I guess I can file a final 1065 for the LLC or continue to file returns in future with zero activity.  Doing the latter would allow the LLC to report the eventual sale of the assets they continue to own although they are used personally by members.

Regarding depreciation recapture -
My current understanding is - It appears assets that have been depreciated with "special depreciation allowance" could have recapture once they are converted to personal use.  Recapture would be depreciation claimed in excess over SL depreciation even though no disposition.  This would be in addition to 1245 recapture if asset sold for  gain at later date.  This is based on what I read today.

[captainl51]

Thanks Rick - original statement should have said 'sale or exchange'.  No sale took place but I did not know if an exchange was deemed to take place if assets of LLC were converted to personal use.  In essence, LLC operated as business for several years and in 2017, Members decided not to operate business any longer and use the assets personally.  Title of assets throughout 2017 is with LLC as they were not distributed to members.  It appears to me that depreciation recapture does not occur until assets are sold by LLC and then only if sold at a gain.  However, when assets are converted from business to personal use, it appears there is a requirement to convert depreciation to SL and the cumulative accelerated depreciation in excess of SL depreciation is reported as ordinary income.  Is my understanding correct?

[Rick19744]

ok.  No distribution of assets.  Are we talking vehicles here?

[captainl51]

Only asset was a boat that was used in charter (captain and crew providing services) - US and Bahamas.

[Rick19744]

Based on the updated facts, you are correct in that any depreciation recapture is not recognized until the asset is sold.

However, you are also correct in that you do need to pick up ordinary income on "excess" depreciation when business use drops to 50% or less.  Don't forget that this "excess" includes any Section 179 or bonus depreciation you may have taken as well.

[Rick19744]

As a side note, love cruises and became spoiled with 3 cruises on the SeaDream.

[captainl51]

Thanks for confirming.

[Rick19744]

Comments as follows:

• While I know you can liquidate a partnership for federal income tax purposes and it still exists for state legal purposes, I have never seen this occur.  You may want to discuss with an attorney.
• Your facts and response are conflicting because you indicate that you had "a sale or exchange of business assets that were converted to personal use"  and then you indicate that "would allow the LLC to report the eventual sale of the assets they continue to own".  These statements are mutually exclusive.  See next bullet.
• What I believe needs to occur, or what happened, is that you distributed out the assets to the members.  Distributions of property from an LLC taxed as a partnership to the member's can be fairly complicated.  The handling of this will vary depending on whether or not this will be treated as a normal distribution or a liquidating distributions. 
• While the tax impact of bullet 3 could vary, regardless, you will need to know your basis in the LLC.  This will become critical as this will provide a ceiling for your "substituted" basis in the assets distributed.
• Distributions of property to a member in an LLC is generally tax free and that is where the substituted basis concept comes into play.  In addition, the member receiving the distributed property steps into the shoes of any future depreciation recapture when the property is sold at a later date.
• So personally, if the property was distributed in 2017, then I think you should have a final return in 2017 and the distributions would be liquidating distributions along with anything else that may have been distributed; ie: cash, etc.  However, as noted previously, you should check with legal as to any legal liability issues that you want to understand prior to making that decision.