I am trying to understand if sale of LLC membership interest is taxed as capital gain.
I am also trying to understand if the following scenario would be short-term or long-term capital gain.
- Jo starts ABC LLC on July 30, 2021. He is the sole owner.
- Jo starts XYZ LLLC on June 30, 2022. He is the sole owner.
- Jo transfers his ownership of ABC LLC to XYZ LLC on July 1, 2022. Now he is the sole owner of XYZ LLC which is the sole owner of ABC LLC.
- XYZ sells 20% of ABC LLC to Peter for $100,000 on August 5, 2022.
Is the 100K taxed as short term capital gain because XYZ LLC owned ABC LLC for about 1 month?
Or is the 100K taxed as long term capital gain because LLCs are disregarded and it is viewed by the IRS as Joe owning ABC LLC the whole time, and thus it was more than a year before the sale?
Note that a single-member LLC is a disregarded entity for federal income tax purposes. As a result, it is as if you sold (or bought) an asset or interest yourself.
There are limited facts here, but at a high level:
- If this is a real world transaction, then I am going to recommend you have a one on one with a tax professional.
- As noted by @tagteam , a single member LLC (SMLLC) is generally (by default) a disregarded entity for federal income tax purposes. This could change if the SMLLC makes an election to be taxed as an association.
- We also don't know what assets are held by the respective LLC.
- The merging of the SMLLCs is a state matter.
- The resulting merger will still result in a SMLLC for the sole owner.
- Depending on the assets held by the respective LLC, you may end up with some ordinary income (Section 1245 recapture as a result of the sale of 20% personal property or inventory).
- Assuming the SMLLCs default entity status is disregarded entity (owned by the sole owner), any gain other than potential ordinary income as noted, will be LTCG since they have been held over one year. This is because for federal income tax purposes Jo is selling the 20% interest based on your facts, since the SMLLC is disregarded.
- You should also review Revenue Ruling 99-5
Thank you so much for this feedback. Yes I will consult with a tax professional if needed but am trying to get a grip on the general concepts first.
1. There was no election to be taxed as an association or corporation etc. Just the default.
2. ABC LLC held no physical assets. ABC LLC held inherent copyrights (not registered yet, but given to the LLC in a contract) to educational booklets.
I will look at Revenue Ruling 99-5 and Section 1245...
@accounts6 here are some follow-up comments:
- I assume that the copyright rights were not purchased by ABC LLC. If that is the case, the state merger of two SMLLCs will be a non event for federal income tax purposes since you owned both disregarded entities.
- Revenue 99-5 will come into play as a result of the new member acquiring a 20% interest in the combined SMLLC; which then becomes a multi-member LLC.
- It is at this point that you may have some ordinary income recognition as a result of selling 20%. This will depend on the assets held in the combined SMLLC.
- Make sure you touch base with your Secretary of State on the merger of the two SMLLCs.
- Additionally, you will need to register the new multi-member LLC, draft an operating agreement and articles of organization.