How to increase capital for Redemption of Membership Interest

[dhdobbin]

Member C transfered membership interest to LLC that results in LT capital loss for Member C. I am showing the loss as a Sch K asset disposition (Screen 19)- which is zero's out Member C's capital account.  I am then entering an M1 adjustment for "deduction of included on sch k but not on books" to reconcile Income. 

It seems the only way I can transfer Member C's capital to the remaining two members is  via an M2 adjustment of misc increase in Capital and then specially allocate.

The goal is to show Member C's capital loss, but no capital gain for the other members (which is triggered when I select "Amount of Loss that is nondeductible" (Screen 19); which would not require an M1 adjustment, bu would then show a corresponding capital gain to the other two members.

Any help would be appreciated.

[sjrcpa]

You do not claim a loss for redeeming a member's interest. For the LLC this is an equity transaction.

If member C has a loss on the transaction it goes on Member C's tax return only.

Other increase/decrease in capital is how you zero out C's capital account and transfer to A and B.

[dhdobbin]

Thank you, so if this is strictly an equity transaction, which it pretty much is, there is an exchange of a small cash payment and customer list, do you know if 8303 is required to be filed?

[sjrcpa]

8303?

[joshuabarksatlcs]

Carnac the Magnificent, or in this forum @George4Tacks , would have shaken the envelope and said:

"Plus Five".

Inside the envelope, he'd pull out Form 8308.

But then, tax filing is no joke.  Referring the question back to @sjrcpa , Joshua waits for the answer without barking, and digresses..  

[sjrcpa]

I couldn't remember the form number.

I don't know how a client list fits in here.

In general, a sale of a partnership interest is a deemed sale of a proportionate share of the  partnership's assets. So if there is anything on the Balance Sheet that would generate ordinary income, then I would file the 8308.

[dhdobbin]

Thanks for the reply. In short, this transaction is a deemed sale of a proportionate share of the  partnership's assets. The customer list is not a balance sheet item that can be monetized and was just a kicker to the deal since he walked away with just a Net capital loss 

[qbteachmt]

"The customer list is not a balance sheet item that can be monetized"

Apparently someone could do so: "there is an exchange of a small cash payment and customer list"

Who paid whom for that list?

[George4Tacks]

Busnac the So So thinks one might have been trying to conjure the 8594 whereupon one would list all of the assets sold in a bulk transfer. 

George4tacks is still unsure as to who sold what. 

[dhdobbin]

The agreement calls for a transfer of membership interest in exchange for a 5K distribution. The original partnership agreement has a provision that each member has shared access to the customer database. So technically the list was not part of the sale or transfer but was put in the agreement as a reminder. So my question is the proper reporting for the transfer of interest an increase and decrease adjustment to Members capital in M2? and does this require the filing of form 8308.

[George4Tacks]

My read is that the member sold their interest for money.

The buyer assumed the seller's interest.

The customer database did not change hands, only the ownership interest.

Seller reports on their tax return as a sale of interest.

The buyer needs to keep track of their outside basis in the ownership interest. 

The partnership shuffles the ownership interest to the new owner and does proper accounting to issue an extra k-1 for that year. 

I assume that seller no longer has a legal access to the customer database. 

[dhdobbin]

George4Tacks - There was no buyer. it was a separation and assignment of membership interest agreement. The recitals of the agreement are: 

1. Assignment. Assignor hereby sells and assigns the Membership Interest to
Company including all of Assignor’s rights and interest in and to Company.
2. Purchase Price. Company shall pay Assignor Five Thousand Dollars
($5,000.00) in good funds and shall deliver to Assignor a copy of Company’s new customer
list including all new customers from January 6, 2022, through May 15, 2022
(the “Customer List”). Both Assignor and Company shall have the right to use and
individually update the Customer List without royalty.

I agree with your post, however because the assignee is the "Company".  I don't think it is possible to generate an extra K-1 for the year, since there are no new members.

The final tax return shows other increases / decreases in all K1's with corresponding M2 adjustments. Which ended up as an M2 wash, elimination of the Assignors capital account, and an increase in the remaining members capital accounts. 

Now the question is whether that was correct, and if the remaining members just need to keep track of their outside basis and record long term capital gains as necessary when their outside basis goes negative due to the assignment of the former members undistributed earnings.

[George4Tacks]

---

@dhdobbin wrote:

George4Tacks adds comments inline - There was no buyer. it was a separation and assignment of membership interest agreement. The recitals of the agreement are: 

1. Assignment. Assignor hereby sells and assigns the Membership Interest to
Company including all of Assignor’s rights and interest in and to Company.
2. Purchase Price. Company shall pay Assignor Five Thousand Dollars
($5,000.00) in good funds and shall deliver to Assignor a copy of Company’s new customer
list including all new customers from January 6, 2022, through May 15, 2022
(the “Customer List”). Both Assignor and Company shall have the right to use and
individually update the Customer List without royalty.

I agree with your post, however because the assignee is the "Company".  I don't think it is possible to generate an extra K-1 for the year, since there are no new members. I agree, but where the seller percentages go?

The final tax return shows other increases / decreases in all K1's with corresponding M2 adjustments. Which ended up as an M2 wash, elimination of the Assignors capital account, and an increase in the remaining members capital accounts. 

Now the question is whether that was correct, and if the remaining members just need to keep track of their outside basis and record long term capital gains as necessary when their outside basis goes negative due to the assignment of the former members undistributed earnings. What are the new percentages for the remaining partners? Did the remaining partners get a distribution of $5,000 to pay the outgoing partner for their percentage? I don't have your answer, but I love asking questions. 

There definitely was a sale of a partnership interest

---