Category: Partnerships & LLCs; Estate & Gift
Subject: Contribution of Loss Property to Partnership
Title: Interaction of Section 1015 and the Partnership Basis Rules
IRC Sections: 1015, 704(c), 722
Filename: 1271.html
Date Produced: 09/95

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Background
Taxpayer A and Taxpayer B (who are mother and son, respectively) formed a family LLC which will be taxed as a partnership. Taxpayer A contributed assets (mostly securities) with a fair market value of $900K and a tax basis of $970K in exchange for a 99.9% interest in the LLC. Taxpayer B contributed $900 of cash for a .1% interest. Immediately after formation, Taxpayer A gave 30% of her interest to Taxpayer B. Shortly thereafter, the securities were sold for a loss of $70,000. Approximately 30% of the loss will be allocated to Taxpayer B.

Section 1015 provides that the basis of gifted assets is, for purposes of determining loss, the lesser of the assets' fair market value or the donor's basis in the assets. Clearly, Taxpayer B's basis for determining loss on sale of his LLC interest would be limited to the fair market value of the interest at the time of the gift under Section 1015.

Issue
The issue is whether Section 1015 overrides the normal partnership basis rules for contributed property or somehow prevents the loss on the sale of the securities from being recognized by the LLC.

Answer
I see nothing to support the idea that Section 1015 somehow overrides the basis provisions of Section 722. In other words, basis of the securities contributed by Taxpayer A should carry over to the LLC. Further, I see nothing in Sections 1015 or 721 to disallow the loss at the LLC level on sale of the securities.

We discussed these facts on September 21, and I mentioned a possible concern about Section 704(c). In other words, would Section 704(c) force an allocation of all the loss to Taxpayer A. I have not resolved that issue. I feel that this is an important consideration.

I think the real exposure is recognition of the LLC as a separate taxable entity. If the LLC were "looked through" and the transaction were viewed as happening between Taxpayer A and Taxpayer B personally, Section 1015 would clearly prevent Taxpayer B from claiming a loss. I think the transaction is vulnerable to attack on that basis. The IRS is well known for attacking family partnership arrangements on substance-over-form grounds. I think this situation is ripe for such an attack.

As an additional thought, I wonder how the new partnership anti-abuse regulations would treat the this transaction.