Scenario…
LLC owns existing apartment complex for ten years… Two current members, 50/50 split…
If I buy out one member’s share of the LLC (rather than a purchase of the property), do I also inherit their depreciated basis in the property?
So, if the complex has already been depreciated by $1,000,000, am I taking on an eventual $500K extra in capital gains, once the property is sold by the LLC (at some far off point in the future)?
You are right bubbaonline. You have not bought a real property the ownership of that apartment has not changed and the depreciation status has not been affected.
I guess that makes that share of the LLC less valuable to me (with the future increased capital gain)… We could start a new LLC to purchase the property from the old one, but then the other existing partner would have to recognize his capital gains and recoup the depreciation from the sale… something he likely doesn’t want to do…
Seeming more complicated than I first thought…
LLC buys apartment for $1. takes loan for $1. LLC net book value is zero.
LLC operates apartment, has income or loss that goes to member’s 1040. LLC takes depreciation of $.50; mortgage is paid down by $.5
LLC net book value is still zero.
If the property increases in value, now you have something to purchase. The increase in value will be a capital gain to be split. Depreciation will be recaptured as ordinary (not capital) income. Presumably you will pay tax on half of this.
Maybe or maybe not the LLC is providing cashflow that’s worth purchasing. I figure not, since if it was spinning off truckloads of cash he wouldn’t be interested in selling. He’s probably trying to dump a cash sucking vortex of doom. His selling point is that the property has increased in value. Of course, if all your value is sucked down the cashflow vortex of doom…
With this in mind, you should value your purchase price based on your expected CASH from any future sale, net of CASH needed to pay taxes on the INCOME from the sale. Figure in your expected CASH flow from operations, your expected CASH, either in or out, from taxes on INCOME or LOSS from operations.
CASH is NOT the same as INCOME.
Thanks…
To keep it simple… the price is based on the equity in the complex… Recent appraisal minus debt (with adjustments for receivables, deposits, etc…) divided by 2, to reflect 50% ownership. Obviosly, anyone that is selling has a reason for it… I just have to find out if I can buy it for a price that makes sense.
I have a pretty good handle on the basics of rental property accounting… and, before offering, I’ll have access to the books (some of which I’ve seen). At this point, the property is slightly cash flow positive… So, any long-term gain will be reduction of debt, and appreciation of property, and hopefully, rising rents and distibution of excess cash flow…
Outside of whether this is a good deal or not (and, I’m not sure of that, yet), I’m worried that by buying his half of the LLC, instead of a direct half interest in the complex, that I’m inheriting his basis in the property… I know that the IRS doesn’t consider LLCs as a taxable entity… For tax purposes, I’ll be in a partnership. I wonder if my half of the partnership could have a different basis than the other partner.
Because, I can’t imagine the IRS wouldn’t require the person that I’m purchasing from to recapture his depreciation at the time of sale.
the member doesn’t have basis. the LLC has basis.
the member doesn’t have any depreciation to recapture. the LLC has depreciation.
with a few exceptions (section 179, suspended rental losses) nothing related to the disposition of the property has yet affected the member’s taxes.
all that gets calculated when the property is disposed of, and should factor in to your purchase price.
Thanks… so, the current member can sell his 50% of the LLC and not generate a taxable event? Even though the depreciation on the property has flowed through to his tax return for the last however many years? I don’t know either way, but that doesn’t seem likely… (just knowing the IRS… lol)
Thanks for your input.
I didn’t say it wouldn’t trigger a taxable event. But the taxable event would be the sale of the LLC interest, NOT anything to do with the property owned by the LLC. The owner didn’t take depreciation. the LLC did.
If he receives more for his LLC interest than he has basis in the LLC, then he will have a capital gain. But THAT is another discussion…
Turns out the LLC is an S corp…
One of the current members says as in all S corps, the income, loss, depreciation, etc… all flow through to the members.
The member that sells his interest has to recapture the depreciation that he claimed on his tax return… If I buy it, my basis is what I paid for it (more or less… an elementary explanation).
In other words, different members of the LLC could have a different basis and depreciation, depending on when they bought in.
The current member that gave me this info is a CPA, and handles the management oversight and tax returns for this LLC…
Just thought I’d pass this information, along… I appreciate everyone’s feedback.
regards,
That doesn’t sound right to me. I’m not going to argue, and I’m not going to take the time to look it up today, but it doesn’t sound right. If the underlying property has not sold, there’s no recapture of depreciation at the corp level, and thus nothing to pass thru.
The S-shareholder only has to do a calculation of the sale price of his interest vs his basis in the interest (which, of course, takes the passed thru depreciation into account). I still don’t see any recapture being triggered by this transaction.
Maybe I missed that class in tax 202.
Dave?
confirmed. the underlying property has not sold, so there is no 4797 calculation to recapture depreciation.
the selling shareholder calculates a capital gain/loss from the sales price and his basis in the stock (which has taken into account depreciation expense to date). this is a Sch D stock sale, just like he was selling IBM stock.
all of this is the seller’s tax responsibility. since you’re the buyer, you don’t care what the seller does, right or wrong.