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Discussion:LLC - Capital account issues

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Discussion Forum Index --> Tax Questions --> LLC - Capital account issues


MSTguy (talk|edits) said:

28 June 2006
Okay - here's some tax accounting questions for you. I shouldn't be struggling with this:

Step 1: There's a sole individual shareholder (X) in an S-Corp. The corporation holds land in which X's basis (really, his basis in the corporation) is $232,000. The FMV of the land is $800,000. There's a $275,000 mortgage on the property.

Step 2: X distributes the land out of the corporation and forms a partnership (LLC) with Y, an individual partner. As Y's contribution into the LLC, Y agrees to pay off the $275,000 debt on the land. In addition, since the land has a FMV of $800,000, in order to be 50/50 partners, Y kicks in cash of $40,000, giving him a total contribution (thus far) of $315,000. Y will continue to fund the LLC until he's contributed 50% of the FMV of the land.

I can't determine how this gets accounted for. Isn't there a carryover basis for X, so his basis (and member capital) is only $232,000, while X's basis so far is $315,000? But if they are 50/50 partners, I don't see how the capital accounts can match up initially. And what should be the carrying balance of the land on the books? Will it just be the $232,000 basis + the $275,000 debt payoff by Y? The difference in FMV and carrying amount is $293,000, which is equal to X's unrealized gain in the property. Does this make sense?

I'm just concerned that the partners' understanding is wrong, too. If X contributed property with a net FMV of $525,000 ($800k - $275k debt), shouldn't X need only pay in an additional $210k? (I'm worried he thinks he needs to pay $400k in addition to the debt payoff, but I'll talk to him about that)

Ugh. I feel my mind twisting....

Dennis (talk|edits) said:

28 June 2006
Oh dear...

MSTguy (talk|edits) said:

28 June 2006
Maybe I shouldn't have used "X" & "Y"? I already found one I messed up. ...

Dennis (talk|edits) said:

28 June 2006
Your opening balance sheet is apparently cash, $40,000; land $800,000; Due from Partner Y $210,000; Capital Accounts $525,000 each. How you get there is painful.

MSTguy (talk|edits) said:

28 June 2006
My problem is booking the first partner's capital at $525k. Although that's his equity in the property, he hasn't realized gain on $293k of that, so he shouldn't get basis in that. His original $232k basis carries over from the S-corp to him to the LLC. If the partnership sells the property now, it would get $800k, but then the cost basis in the asset is booked at $800k, and he's ends up never picking up a gain. But I agree with the receivable from Y for $210.

Is it appropriate to have unequal capital accounts when, in fact, the partner's are equally invested?

Dennis (talk|edits) said:

28 June 2006
Sec. 311(b)

MSTguy (talk|edits) said:

28 June 2006
You know what - I have to claim complete ignorance on this. I didn't think 311 applied to S-corporations. Otherwise I wouldn't have had this question at all. I'm too used to thinking that distributions from S-corps are nontaxable to shareholder (assuming basis) - but that's cash distributions.

Dennis, that's all you had to say! Thanks... although now I've really got a problem - how to deal with the gain.  :)

Will (talk|edits) said:

28 June 2006
A member’s capital account does not equal his tax basis in an LLC for a number of reasons. First would be the problem you are wrestling with now, the tax-free contribution of property at FMV. Another reason would be the revaluation of LLC property, and the corresponding capital account adjustments, allowed these entities in certain situations.

IMO, the book entry would be what Dennis has laid out, and member X's tax basis is the basis transferred from the S-corp.

I have this link bookmarked for review before discussing LLC transactions with clients: http://www.mmmlaw.com/publications/article_detail.asp?serviceid=3&articleid=31 Perhaps you will find it useful.

(My apologies in advance if external-link postings are not allowed on this site.)


Will

Note: External links are welcomed on this page, as long as they add value. This is such an example - thanks for adding it!

- Tim Doyle, TaxAlmanac Moderator - Talk to me 13:32, 28 June 2006 (CDT)

Dennis (talk|edits) said:

28 June 2006
What makes it worse, I think, is there seems to be no reason why the Corp couldn't have been the partner instead of the shareholder.

MSTguy (talk|edits) said:

28 June 2006
I agree - but want to hear more? In reality his original basis issue is VERY difficult to pinpoint. We find vague memos dating back to the late 80's detailing the origin of this property and the 1st partner's involvement. There were lawsuits, unpaid buy-outs, all kinds of fun stuff. So you can understand my frustration with the issue. Too bad not everyone's an accountant.

MSTguy (talk|edits) said:

28 June 2006
Will - X's basis in the S-corp wasn't the $525, it was $232, meaning there had to be a realized gain in order to pick up the FMV basis in the partnership. It was my fault that I wasn't aware of appreciated assets being taxable to shareholders on distribution.

For what its worth, I'm getting my Masters in Taxation - but I have yet to take the course called "Pass-thru entities" which, of course, deals with s-corps and partnerships. Not much of an excuse, but its something.

MSTguy (talk|edits) said:

28 June 2006
Will - Thanks for the link. It is actually very useful and detailed.

JimS ME (talk|edits) said:

29 June 2006
It is my understanding that the gain would be realized by the S-Corporation prior to the distribution. Then the numbers begin to work. X contributes the land @FMV, a loan to X is recorded for the mortgage, along with the net contribution. Y contributes cash equal to X's NET contribution.

However, I'd think long and hard about the S-Corp being the LLC Member so that the original gain doesn't have to be recognized. OR perhaps the LLC should just rent the land from the S-Corp.

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