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Author: criser Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 740893  
Subject: Re: Using a side business to subsidize ER costs Date: 10/11/2000 1:05 PM
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I wrote: Transfers of appreciated property into the business in exchange for ownership is another big area of difference. If you bring in owners after formation, there's a good chance that such transfers (e.g., transfer of an appreciated piece of real estate or intellectual property rights) will be taxable to the contributor. Not so with an LLC. Contributions in exchange for LLC interests aren't taxable as a general matter.

Then TheBadger responded: This can not be so; or at least not in the manner I am reading it. If I contribute property in exchange for X% interest (shares) in an "S" corp or LLC one of two things must occur:

1. I have a deemed sale and if the property (whatever it might be) has appreciated; then I have some form of capital gain; or,

2. I have an exchange and the receiving entity must assume my basis in the property contributed & similarly my basis in the shares received becomes the same as my old basis in the property contributed.

To permit anything otherwise obviously would create a loophole big enough for your average MAC truck & immediate abuse by your average savvy taxpayer.


If appreciated property is contributed to a corporation (S or otherwise) in exchange for stock it is a taxable exchange. However, section 351 generally prevents such exchanges from being taxable if certain control and ownership requirements are met (the 80% requirements, which usually will only apply in a startup situation). Likewise, any contribution of appreciated property to a partnership or LLC in exchange for partnership or LLC interests is a taxable exchange. However, section 721 prevents nearly all such exchanges from being taxable, and there is no control and ownership requirement.

Here's an example: Carl owns unimproved real estate which cost him $50,000 in 1980, but which has a fair market value of $200,000 in 2000. He transfers the property to the ABC Corp in 2000 for 40 percent of the stock in the corporation having a fair market value of $200,000, the remaining 60 percent of the stock having been issued by the corporation in 1995 to other persons for cash. Carl will realize a taxable gain of $150,000 on this transaction. If instead of a corporation (S or C, it doesnt' matter in this context), ABC had been an LLC or partnership, Carl would have realized no taxable gain. He simply would take a $50,000 basis in his ABC LLC membership interest.

There are anti-abuse rules that prevent using an LLC or partnership transaction to make a disguised tax-deferred sale, but otherwise, there is nearly unlimited freedom to make tax-free contributions to LLCs.
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I wrote: Transfers of appreciated property out of the business is another area of difference. Business owners often want to redeploy assets to a new or other business. If an appreciated assets (e.g., land) is distributed out of an S corp, it will cause the gain to be taxable. Not so with an LLC as a general matter.

And TheBadger responded: Again I need to disagree. An "S" can distribute whatever it has (money, land, etc.) and the distributee (shareholder) receives it at the same proportionate basis as was held by the "S". There is no step-up in basis & there is no taxable event when a distribution takes place.

Sorry, that's just not correct. A distrubution of appreciated property out of a corporation, S or C, is a taxable event that causes gain to be recognized by the corporation. See Sec. 311(b)(1). In the case of an S corp, the gain is passed through to the shareholder. If the fair market value of the distributed appreciated property exceeds the shareholder's basis in his stock, the shareholder recognizes capital gain. In this kind of situation, with an S corp there is only one level of tax as opposed to the two levels of tax there'd be with a distribution of appreciated property from a C corp.

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