how to handle a mid year conversion from LLC partnership to single member LLC?

[scphil21]

Last year an LLC which holds a residential rental converted from a multiple partner LLC to a single member LLC (just me).  I have filed a final 1065 for the LLC for the time it was a partnership and I was going to put the rest of the p&l on my schedule E.  That is fine for rent and expenses.  But in personal turbo tax I am unable to find how to allocate only a partial amount of the depreciation, not the full year.  Depreciation of my acquired interest starts from when the transaction happened, but my original interest depreciation should have no change, just an allocation between the 1065 time and schedule E time.  I can't see a way to override the software to take less than the full year.  Any ideas?

[Carl]

It doesn't work the way you may think. First, it all depends on how you acquired the 50% that was owned by the ex-partner. Did you buy them out of their share? Maybe they passed away and you inherited it? Or they could have gifted it to you?

Precisely how you legally acquired the ex-partner's share will determine how you will enter this for the SCH E on your personal tax return.

[scphil21]

I bought their interest, which was 33%.

[Carl]

I fully expect that your own K-1 (not just your ex partner's) is marked as final. Since you paid for that 33% and now own 100% of the property,  you'll be entering the property as an entirely new rental property with a new cost basis, and depreciation starts all over from day one, for the next 27.5 years.

Your cost basis on the new property is:

What you paid for your share originally when you purchased it, plus what you paid for the 33% you purchased from the partner. From that total you will subtract the depreciation that *YOU* have already taken on the property while it was in the partnership.  This total will be your new cost basis. Add to that any property improvements that "you" paid for. You can not include in the property improvements any that the ex-partner contributed to those improvements.

Enter the property as a new rental property with an in service date no earlier than your closing date on the purchase from the partner.  You'll indicate that you purchased this property new.

The depreciation "you" got while it was in the partnership is already reflected/reported on the K-1. The depreciation your ex partner took is theirs to recapture on their own tax return - as you already know, of course.

Now, you will have to document somewhere the depreciation "you" took on the property while it was in the partnership, as you will need to include that amount in your depreciation recapture should you sell the property in the future.

[scphil21]

Thanks Carl.  When calculating the basis, do I make the prior depreciation/improvements adjustments before or after accounting for the land portion of the cost? 

ie, do I add up the actual cost, then take the percentage of structure value THEN do the adjustments OR

I take the actual cost, do the adjustments, THEN adjust for structure value?

I think it is the first one but want to be sure.

[Carl]

Yep, as expected this is not simple.

First, you need to figure the adjusted cost basis of your original 66-67% after having dealt with the final K-1.

Take the original cost basis of that 67%, add to it the cost basis (or share thereof) any property improvements you paid for during the period of time it was in the LLC. From that total, subtract the total amount of depreciation taken on all assets (That is to say, your share of depreciation on all assets). This will give you the adjusted cost basis of your original 67%.

Add to that adjusted cost basis whatever amount you paid the partner for their 33%, and that total gives you your new cost basis that will be used on the SCH E part 1.

So assuming no property improvements were done in 2021 after the LLC was dissolved, you'll only have one single entry in the assets/depreciation section for your "new" acquisition. Depreciation will start all over using the new cost basis, for the next 27.5 years.

For mortgage interest, you will need to see what was claimed (by both you and your partner) on the LLC 1065 return, The remainder will be claimed on the SCH E by  you.  Same holds true for property taxes and insurance.

The math may take a bit, as you'll have to look at the ALTA closing statement you received when you closed on the purchase of your partner's share to see if you paid your partner or were reimbursed by the partner for a portion of property taxes they paid, and possibly for any portion of the insurance they paid.  You'll want to be careful that you don't "double dip" on those or any other items without realizing it.

Now, for figuring which part of your newly figured cost basis to apply to the land, what you do is pull out your latest property tax bill for that property. Take a look at the tax values and you want to figure what percentage of the total tax value is allocated to the land. Use that percentage to determine what percentage of your cost basis to allocate to the land. (This is the preferred method of the IRS.)

[M-MTax]

 From that total you will subtract the depreciation that *YOU* have already taken on the property while it was in the partnership.

Not at all sure this is right because the partners don't "take depreciation on the property". The K-1s show net RE income with depreciation deducted at the P-Ship level. 

Maybe @Rick19744 knows how to deal with this. Reading through the posts results in kind of a mess.

[M-MTax]

 (This is the preferred method of the IRS.)

Where does it say that's the preferred method?

[Rick19744 · Accepted solution]

This transaction is to be handled in accordance with Revenue Ruling 99-6; situation 1.

• rr-99-6.pdf (irs.gov)
• This event is treated as a termination of the partnership
• The partners are deemed to have received a liquidating distribution of their share of the assets.
• You (partner B in this Rev Rul) will take what is called a "substituted basis" in your share of the assets distributed out.  This requires you to allocate the assets received in liquidation in proportion to your outside tax basis.  There are specific steps that need to be followed in determining the substituted basis of assets distributed in liquidation.
• Your substituted basis in the assets received will "tack" the holding period and depreciation method of the LLC to the extent the substituted basis does not exceed the basis when held by the LLC.
• If your substituted basis in the assets received exceeds the basis when held by the LLC, the excess portion is deemed a new asset; new holding period and new depreciation
• Your basis of the purchase of your partner's interest (partner A in the Rev Rul) is the purchase price which is then allocated to the assets purchased.
• The purchased assets will receive a new holding period and depreciation method and period for applicable assets.
• Yes this gets complicated as you now have a bifurcated basis in the assets

[scphil21]

ok thanks Rick.  It seems I'm back to the original issue of TurboTax not supporting a bifurcated depreciation schedule. :(

[scphil21]

so let me know if I have this one right (sorry I'm not a cpa)

For the acquired part of the LLC the cost basis is the purchase price and the basis for depreciation is cost basis times % allocated to structure.  Then the basis for depreciation is amortized over 27.5 years as if I had bought a new property (which I have, duh).  This part is easy.

(cost - value of land)/27.5

For the part of the LLC that was mine to begin with, the cost basis is my original purchase price plus my portion of the cost of improvements minus my portion of any depreciation taken since inception.  And my basis for depreciation is the original basis for depreciation minus depreciation taken during life of llc times my per rata ownership.  I will continue taking my per rata amount of this for 27.5-life of llc years.

((original cost - value of land) + cost of improvements - all depreciation taken during life of LLC)  * my original percent ownership  taken every year for 27.5-life of llc more years.

This is in the most basic case.  I understand there could be things which complicate it but on the most basic level is this how I should think of it?

[Rick19744 · Accepted solution]

While TT can handle this, it will take you inputting the correct asset cost and depreciation based on the transaction.

1. For your 1st paragraph, you need to allocate your purchase price among the assets purchased as you described.  Yes, this is the easier of the two components.
2. For the 2nd paragraph, not sure you have a handle on this.
   1. You should have been maintaining a tax basis of your investment in the LLC
   2. Your share (%) of the assets distributed out to you have a basis as well based on how the asset was depreciated (or not depreciated).
   3. You will then need to allocate your tax basis in the LLC among your share (%) of the assets distributed in liquidation.  
   4. By way of a simple example (real life unfortunately is not as simple).  If your tax basis was $50,000 and the assets distributed to you had an adjusted basis of $45,000, you would need to allocate that $45,000 in proportion to your $50,000 tax basis.  Keep in mind, that the $5,000 excess becomes a new asset(s) as noted previously.
   5. There are specific rules that govern how to do this allocation under Section 732.  Beginning with your tax basis:
      1. Subtract out cash / marketable securities
      2. Any remaining basis is allocated to unrealized receivables and inventory equal to the LLCs adjusted basis
      3. Remaining basis is then allocated to the other distributed assets equal to the LLCs adjusted basis
      4. Any basis increase (the distributee member's basis over and above the LLCs basis in the distributed assets) is then allocated to appreciated assets (other than unrealized receivables or inventory) in proportion to each asset's respective amount of any unrealized appreciation.  However, basis should not be allocated in excess of FMV.
      5. If there is still remaining basis increase to allocate, it is allocated to assets (other than unrealized receivable or inventory) in proportion to their FMV.
   6. Unfortunately, regardless of the size of an LLC taxed as a partnership, the rules can be cumbersome and complicated.

[scphil21]

thanks for all the help.  unfortunately this is like feeding creampuffs to burros.  I still don't get it.

I'm going to truck with my portion of the original depreciation plus the new depreciation and if the irs wants to fix it for me they can be my guest.  This isn't something that will get sold in my lifetime so the tax basis really doesn't matter.  The kid can deal with it decades from now.

[Rick19744]

As a final comment, well maybe two:

• While one doesn't like to practice tax on the premise that the IRS won't figure it out, it is likely this is over the head of most.
• Make sure you don't have plans to gift anything to anyone, as if you do, you will definitely need your tax basis.