Discussion:Contributed property distribution

Before distribution, a 500k loan was taken out on the property and all of the cash was distributed to Uncle.

At contribution date the land had a FMV of 900,000. The basis of the property is 450,000.

Does the Uncle recognize precontribution gain as folows:

FMV 900,000 Basis (450,000) Gain 450,000

Shouldn't i factor the loan in the above gain/loss calculation? Or would the loan be accounted for on the distribution of the property to the nephew:

Decrease in basis 450,000 - property Increase in basis 500,000 - loan

Or am i way off?

Any input would be appreciated.

If Uncle contributed appreciated property to an entity taxed as a partnership then Uncle is taxed when that property is sold within 5 years. Not sure of immediate taxation when it is distributed if your LLC is taxed as a partnership. I'd have to research that question. Clearly taxable at FMV if the LLC chose C or S Corp tax status. Why didn't Uncle just increase his mortgage then gift the property to Nephew before forming this LLC with the other 4 properties to keep this cleaner?

If this is taxed as a partnership, basis of the LLC interest is adjusted to add shares of recourse debt for each partner and when property is distributed subject to debt each partner is treated as receiving a cash payment for the reduction of recourse debt. Uncle also got a cash distribution for the loan proceeds he received.

In the meantime, interest on that $500K loan proceeds is not deductible as interest related to the rental activity. It must be separately stated on the K-1 form for the partner to look at how to claim depending on use of the proceeds.

I'm not sure why these guys do half of the things they do. They are working with all inherited cash/property. We just picked them up as a client earlier this year.

The entity is a partnership.

I believe the loan must not be considered in the precontribution gain calculation. Is this correct?

A few more questions concerning this transaction for the forum...

Does the gifting of the partnership interest to the nephew effect tthe pre contribution gain? (ie: would the precontribution gain be calculated at 55% of the 900,000 FMV of the property)

Also, would the debt on the property factor into the precontribution gain?

You said the was taxed as a partnership. Uncle put in appreciated property worth $YYY at his basis of $XX. He declared a gift at FMV of $YYY x 45% to his nephew for the partnership interest. Uncle's capital acount containing opening basis of property he put is debited for 45% of basis of $XX and credited to his nephew's capital account. (Uncle's cost basis transfers to the nephew.) Uncle and nephew have increased basis for 55% & 45% of debt against properties. Uncle has basis decrease for funds he received when a mortgage was increased. Nephew has basis decrease for cost basis of property distributed to him. Nephew has basis increase for debt passed out that attached to that property. Uncle and nephew have basis decrease to reduce debt shares for 55% and 45% of the debt on that property now all nephew's outside the partnership.

Crunch the numbers. Basis cannot go below zero without declaring gain.

I'm not sure how the numbers work for contribution of appreciated property. You need to do some research. I know if it is sold within 5 years then uncle recognizes gain. Also not sure how that is affected by immediately taking out to give to nephew. Would have been much cleaner for uncle not to have put in in the first place. You have some homework to do on this one. Code section 704 etc.

Issue 1: Do the Sec. 1.707-3 disguised sale rules apply here?

Issue 2: Do the Internal Revenue Code § 737 pre-contribution gain rules apply here?

Issue 3: Do the Internal Revenue Code § 704(c)(1)(B) pre-contribution rules apply here?

R2 I see where you are coming from on the $500K Uncle took from the loan proceeds and potential for disguised sale treatment. Uncle has effectively removed his untaxed equity in that property by taking the loan proceeds. This one is out of my arena of experience which is why I asked the OP to do his homework.

Is it Precontribution gain or a disguised sale? If it is a precontribution gain, does the Uncle pay on all of the precontribution gain(FMV-basis at time of contribution) or does is the gain comutted at a discount b/c 45% of the LLC was gifted to the Nephew???

I think the above is moot b/c in the OBRA committee reports there is language which reads " If the transfer is instead part of a disguised sale, the committe reports suggest tat Sec. 07 rather that 704 is the governing statue. I found the preceeding at page 7 of...

http://www.allbusiness.com/legal/laws/354243-1.html

So now, i believe the events represent a disguised sale.

So now, how do i treat the disguised sale?

Uncle receives 500k Nephew receives property with FMV of 900,000 (basis of 450,000) and assumes liability of 500k

Are these two separate disguised sales? Does it matter?

Back to the disguised sale rules...

The LLC gets a stepped up basis to $900K FMV. Subsequent distribution to nephew would be at same FMV now on the LLC books and subject to debt. Nephew's basis is the $900K FMV which is booked as a distribution to him by debiting his capital account. He gets a credit to his capital account for the $500K of debt distributed with the property. Looks like this could cause their capital accounts to get out of proportion. Also, if Nephew doesn't have sufficient tax basis from his 45% share of the other 4 properties that Uncle contributed, he could have a gain himself. No info given on any shares of debt that might affect his basis. Basis in his LLC capital account can't go below zero without having a taxable gain.

In my opinion, these types of transactions are to complex to weed through all the necessary information in this forum.

In my opinion, speculation about an answer helps no one.