A member sells their interest in a three-member LLC partnership to a new member outside of the LLC. The selling member loaned fund to the LLC. Is the loan taxable as canceled debt as the selling member is not looking for repayment?

[IRonMaN]

If he doesn’t want it back was it a loan or equity?

[AzzurriT]

It was a loan.  He sold his equity to an outside member

[IRonMaN]

Did he formally notify the partnership that he was forgiving the debt?  Does the partnership really want to pick up income for forgiveness of debt or does it and the former partner wish to convert it to equity?

[AzzurriT]

The selling partner does not want to convert to equity and is not looking to collect on that loan.  When he sold his equity, he was done with the business.  Can the loan convert to equity for the remaining members?  

[IRonMaN]

Converting to equity adds to his basis.  But back to my prior question that you didn't answer, did he formally notify the partnership that he was forgiving the debt?

[AzzurriT]

Yes he did inform them of cancelling the debt.  My apologies

[IRonMaN · Accepted solution]

Then you have debt forgiveness income.

[AzzurriT]

Thank you

[qbteachmt]

What does the sale have to do with the debt? You included all of that as if they apply to each other. Does the buyer think they got the debt position in the purchase?

[AzzurriT]

The question was asked on how to handle the outstanding debt that the selling partner held.  When they sold their interest, they are not seeking repayment.  I was asking to see if there were other options besides debt forgiveness income.