Discussion:Section 732 basis adjustment

My client just notified me that the three members of his LLC (93% owner, 2% owner, 5% owner)are all selling their interest to four other individuals. There is no section 754 election in effect with this entity. If I am reading the technical termination rules correctly there will be a deemed liquidating distribution to the purchasing members(from old LLC) followed immediately by deemed contribution of same property to the "new" LLC.

Section 732 states that the partners basis in assets received in a liquidating distribution will equal the partners adjusted basis in his partnerhip interest. Assuming the FMV(which new partners are paying) is greater than tax basis, won't the partners receive a step-up in basis (= to partnership interest) for these assets (at time of liquidation) and then simultaneously transfer the assets with the new step-up basis to the partnership? So the partnership will have the new step-up basis on its books as opposed to the 754 election which doesn't adjust the partnerships books.

If I am correct with what I wrote above,doesn't this seem like the most sensible way to go about it since there are going to be four new owners and none of the prior owners will be with the "new" LLC?

Discussion:Partnership - Technical Termination

Reg 1.708-1(b)(4)states:

If a partnership is terminated by a sale or exchange of an interest, the following is deemed to occur: The partnership contributes all of its assets and liabilities to a new partnership in exchange for an interest in the new partnership; and, immediately thereafter, the terminated partnership distributes interests in the new partnership to the purchasing partner and the other remaining partners in proportion to their respective interests in the terminated partnership in liquidation of the terminated partnership, either for the continuation of the business by the new partnership or for its dissolution and winding up. In the latter case, the new partnership terminates in accordance with (b)(1) of this section . . . 

So I am not sure that the new owners are contributing assets to a new partnership.

Of course related parties, the types of entities involved as members, Section 751 assets, the actual character of the transaction, Massachusetts (if applicable) law on LLC terminations, and the history of the old LLC would affect a conclusion.

So, for now, I suggest reading the above thread, in addition to learning all one can on partnership law. Especially commentary since some regs have been superceded by new law. And some sections trump other sections.

In the few sales of equity interests I have been involved in it has been a major chore to get clients and attorneys to use precise terminology (in their dealings and in the paperwork) so that conclusions regarding the tax effects can be made. Toss in the complexity of partnership tax law and nailing down the tax effects can be difficult. Toss in the fact that written agreements are often not followed and it is difficult to treat future operations correctly. And if Hammer is dealing with the local eggheads he is on the adventure of a lifetime.

Sec. 732. Basis of distributed property other than money

(b) Distributions in liquidation

     The basis of property (other than money) distributed by a
   partnership to a partner in liquidation of the partner's interest
   shall be an amount equal to the adjusted basis of such partner's
   interest in the partnership reduced by any money distributed in the
   same transaction.

I am trying to determine the adjusted basis of the property after liquidation to the partners (not the partners basis ) It seems the basis of the property itself, according to section 732(b), is adjusted upward or downward to "equal the adjusted basis of such partner's interest in the partnership". Since there is a deemed liquidating distribution as of the date of the sale, the new partners interest in the partnership would be the purchase price of buying out an existing partners interest (no prior 754 election exists)

The basis of the property is then adjusted, and finally a contribution of this property is transferred to the new partnership with the substituted basis of the property. At least this is how I am reading it. Since none of the prior partners will be in the new partnership I don't see how a section 754 election would be helpful. Do you agree? Disagree?

Thanks again for any thoughts.

http://www.bizzer.com/Pship/Outline/lect7b.htm

also see the part about partnership terminations.

I don't find that in the reference books, however it does seem to me that is the way it should be treated since a liquidating distribution is deemed to occur. All the reference books and tax almanac posts seems to point to a 754 election, but in my situation, the new LLC will have all new owners.

Thanks.

During the Code Section 708(b)(1)(B) technical termination, the partnership is deemed to contribute all its assets and liabilities to the new partnership in exchange for an interest in the new partnership. The partnership then liquidates by distributing the interest in the new partnership to the purchaser and, if applicable, the other partners. The new partnership continues the business.

Thus, for a Code Section 708(b)(1)(B) termination, there is no liquidating distribution of the partnership assets.

The distribution of interests in the new partnership by the terminating partnership is not a sale or exchange of interest in the new partnership. Reg. Section 1.761-1(e).