Discussion:Asset Sale of a C Corporation to a single member LLc

My client has a single member LLC invested in real estate and in 2005 he told me he purchased several real estate properties (over 40) so I included them in his single member LLC. However, the accountant for the seller (sale of the LLC, which is a C Corporation) provided me this year with stub period financials for the first two months of 2005 (sale date of 3/1/05). The C Corporation LLC had NOL's of$24,401 at 12/31/04 and the losses for the two month period ended 3/1/05 were $62,932. One question I have is whether or not I complete a tax return for the purchased C Corporation for the entire year, even though my client purchased 3/1/05 (Not sure what the seller's accountant did with stub period as he has not returned my calls). More importantly since the agreement was for the sale of assets ("Purchaser shal purchase Member's sole interest in the Company for the sum of $1, plus the assumption of the liabilities of Company.") will the NOL's get carried forward to the new owner who files taxes for the C Corporation LLC purchased?

This makes it sound for tax purposes like a stock sale. If this LLC is being taxed as a corporation the Member's interest would be their "stock" in the entity not the entities assets.

It sounds as though your client wasn't all that clear about what he bought, which led to your confusion. He shouldn't have done this transaction without legal and accounting advice, but what's done is done. Why anybody would have elected C corp treatment for an LLC holding real estate is a total mystery, but the seller got out of it with a more or less whole skin (and may have pulled a fast one on your client) by selling the interest (one level of tax) rather than the assets (two levels). Now the problem is your client's. You're going to have to decide what to do with this silly C corp. If the client intends to hold the underlying property for long-term appreciation, it may be best to bite the bullet and elect to have it treated as a disregarded entity. That will be a taxable event (see Reg. Sec. 7701-3(g)(1)(iii)), and the C corp NOLs will be lost, but future appreciation in the value of the property will not be trapped in a C corp.

Assuming this entity didn't leave a consolidated return group, it wouldn't have a short period return for the pre-acquisition period. It must file a return for the calendar year ended 12/31/05, and as the owner at year end, your client is responsible for filing that return. You need those pre-acquisition numbers to file the 12/31/05 return for the corporation. You'll also need to amend your client's 2005 return to take the corporation's assets out of his SMLLC.

The NOLs come along with the corporation under IRC Sec. 381, but their utilization is limited by IRC Sec. 382 due to the change of ownership. (This is basic Sub C stuff.) The maximum NOL that can be deducted in any given year is calculated by multiplying the value of the corporation at the date of change of ownership (in this case, probably, what the client paid for it, which would be the amount of the liabilities plus $1 -- which suggests the corporation was upside down in the real properties, or at least had borrowed up to their FMV) by the long-term tax exempt rate. You can find the rules for calculating this in IRC Sec. 382 and the regulations thereunder.

If it was indeed a stock sale (ie: the client purchased the ownership of the LLC taxed as a C corp)then the NOL would stay with the newly-acquired LLC. The LLC would carry on as before, with no need for short years.

If this was an asset sale(the client purchased the assets of the LLC taxed as a C corp from the LLC, but did not purchase the ownership of the LLC)then your client does not get the NOLs. They stay with the old entity.

Assets sold to LLC may trigger gain / loss for the Corp. Essentially your client did not buy the corp but the assets of the corp. Talk with the Corp's accountant and clear things out. You 2 are not on the same page :P

That's what happens when attorneys give tax advice. Be sure to point that out to your client.

I've been trying to think about what the FMV of the corporation was at the date of acquisition (for purposes of calculating the IRC Sec. 382 limitation on utilization of the NOLs). Surely it would be the FMV of all of the properties, minus the liabilities. If the seller was willing to unload these properties for, in effect, the mortgage balance, their FMV can't be much more than the amount of liabilities assumed. In that case the FMV of the corporation may be zero, or the $1 your client paid, and while the NOLs technically come along, they will never be usable.

If that's the case, there may not be all that much gain inherent in the real estate, the NOLs have no real value anyway, and electing to have the entity disregarded going forward may be the best thing to do, especially if your client intends to hold these properties for the long term.

My concern is the S corporation LLC purchased by my client for $1 for 27 real estate properties with a cost basis of $871,000 and mortgages payable (private finance and banks) for $1,200,000. The problem here is 8 of the properties were sold after the purchase date of 3/1/05 and before 12/31/05 and the gains could total as much as $100,000 or more. My client saw little cash as a result of these sales since the private mortgages exceeded the asset cost in all cases.

The S corp sold the properties, the gain is the difference between the sale price and the inside basis, and as far as I can see your client is hosed. You may have depreciation recapture to deal with too.

Maybe others will have some more creative ideas.

Is there any relief for this situation or the fact that several other properties which had debt exceeding cost basis were sold at gains over $100,000?

I was wondering if anyone advised the buyer that it isn't uncommon -- even when the entire corporation is purchased -- that all the loans/mortgages may be called. In fact, it isn't uncommon in closely-held corporations for a loan to be called when the majority owner changes. Did the buyer check the mortgage documents before the sale? Many times there are stiff pre-payment penalties as well. It also looks as though, there may be some fraud taking place if the mortgage was still in someone else's name while the title was transferred. (Note to seller: I bet you wish had paid the small premium and bought non-recourse loans.)

As others have noted, it is long past the time to get someone involved who knows something about real estate, taxes, financing and how they all play together inside a corporation. For a couple thousand dollars worth of advice, your client could have kept himself out of this mess. If you want to hit this one out of the park, Dacowles16, find such an expert and help your client to mitigate the damages. You sound like a sharp CPA but if this is not your area of expertise, you really need to bring in a designated hitter.