this can be a lot more complicated than you think especially if the LLC has debt.
Transfers among family members identified as gifts may trigger sale or exchange treatment for the donor to the extent a decrease in the donor’s share of partnership liabilities is treated as a deemed cash distribution. Rev. Rul. 84-53 illustrates basis allocations and adjustments that may occur when a partner owns an interest in a partnership and disposes of only a portion of such interests.
Gift of a Partnership Interest
IRC section 704(e)(2) addresses the allocation of distributive share where the partnership interest is created by gift. The gift of a partnership interest may have a tax impact on the donor. The following factors should be considered when determining whether an issue is present:
- Whether the partnership interest transferred was properly valued;
- Whether the adjusted basis of the partnership interest was correctly stated;
- Whether allocation of the distributive share of partnership items between the donor and donee was correctly computed;
- Whether the transfer resulted in debt relief to the donor;
- Whether debt relief results in a deemed sale of a partnership interest;
- Whether the allowance of suspended passive activity losses was correctly computed;
- Whether there is a gift tax return requirement and a gift tax liability
The gift of a partnership interest free of liabilities (that is, has no share of partnership liabilities under IRC section 752) is not subject to income tax. If the partnership interest is encumbered by debt, or the donor partner shares in partnership liabilities pursuant to IRC section 752, there is potentially a taxable event.
Gift of a Partnership Interest Unencumbered by Debt
The basis of the gift of a partnership interest in the hands of the donee when the partnership interest is not encumbered by debt is generally determined as follows:
- For purposes of determining future gain, the donee’s takes a carryover adjusted basis from the donor.
- For the purpose of determining future loss, the donee’s takes a carryover adjusted basis from the donor, except that if the donor’s adjusted basis was greater than the fair market value of the property at the time of the gift, the basis to the donee is limited to the fair market value at the time of the gift.
Effect on Passive Losses
The gift of a partnership interest with accumulated suspended passive activity losses will not trigger an allowance of the losses to the donor or donee. See IRC section 469(j)(6)( b ). The suspended passive activity losses are instead added to the donor’s adjusted basis in his/her partnership interest immediately before the transfer. This step up in basis carries over to the donee under the general rules of IRC section 1015. See IRC section 469(j)(6)(A). The step-up is to the donor’s outside basis in the partnership under IRC section 705, rather than the partnership’s inside basis in its assets. Any tax benefits to the donee are deferred until such time as the partnership interest is disposed of in a taxable transaction.
Moreover, the step-up in the donor’s outside basis has limits. If the addition to the donee’s basis resulting from unused passive losses exceeds the fair market value of the partnership interest at the time of the gift, and the donee subsequently disposes of the interest in a taxable transaction resulting in a loss, the donee’s basis is limited to the fair market value at the time of the gift.
