Category: Nontaxable Exchanges; Sales &
Exchanges; Partnerships and LLCs Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Background Partnership A wishes to sell the law office to a newly formed entity, B. It is anticipated that B will be set up as an LLC taxed as a partnership. The building will likely be sold on the installment basis. Entity B will be owned equally by Messrs. C, D, and E. E is unrelated all other participants. A and D are father and son. The basis of each partner's interest in the A partnership is $80,000. The basis of the law office is $190,000 and the fair market value is $540,000. Comments It seems clear that special rules do exist in this case to change both the conclusions set forth above. Section 707(b)(2) denies capital gain treatment with respect to a sale of property between commonly controlled partnerships. Common control is defined for this purpose as two partnerships more than 50% of the capital or profits interests of which are owned directly or indirectly by the same persons. The family attribution rules of Section 267 are made specifically applicable. In this case, Mr. C is a 33-1/3% owner of both entities. The father-son team, Messrs. D and A, are also 33-1/3% owners of both. After application of the attribution rules, we have two partnerships owned to the extent of 66-2/3% by the same people. Accordingly, the rules of Section 707(b)(2) are triggered, and any gain on the sale would be treated as ordinary income. Section 453(g) provides that installment reporting is not available for sales between certain related entities. Section 1239 and 707(b) are made specifically applicable to this determination. In other words, if a Sections 1239 or 707(b) apply, then so does Section 453(g). Accordingly, installment reporting is not available either. Section 453(g) does not apply if it can be established to the satisfaction of the IRS that the sale did not have as one of its principal purposes the avoidance of federal income taxes. Good luck doing that. Would the result differ if instead of the facts set forth above, the A partnership distributed the law office to the Messrs. A, B, and C; and thereafter, Messrs. A, B, and C individually sold their undivided interests in the law office to the new LLC? I think the result with respect to Sections 707(b)(2) and 453(g) would be exactly the same notwithstanding the change in facts. The statute at Section 707(b)(2) says "...in the case of a sale or exchange directly or indirectly...". Emphasis added. Remarkably, there is no case law on the subject of indirect sales. It seems to me, however, that if anything could be viewed an indirect sale between Partnership A and the LLC, the second fact pattern set forth above would be so viewed. With respect to the mechanics of the amount of gain recognized, I think the results of the second scenario are the same as those of the first. A nonliquidating distribution of partnership property (other than cash) does not give rise to gain or loss to the partnership or the partner. Section 731(a) and 731(b). Basis of noncash property distributed in a nonliquidating distribution carries over from the partnership to the distributee partner. Section 732. Accordingly, distribution of the law office building to Messrs. A, B, and C would allow them to then individually sell the building to the LLC, equally divide the proceeds, and end up with the same gain that would have been recognized had the A partnership sold the building. This all assumes that there are no special allocations in the A partnership agreement and Section 704(c) is inapplicable. In addition, it seems unnecessary to trigger 100% of the gain in this case. If the law office building were distributed to the partners, Mr. C could contribute his one-third interest to the LLC tax free under Section 721. This would avoid recognition of one-third of the gain inherent in the property. |
