IRS Revenue Ruling
1999-5

 Code Secs. 721, 722, 723, 1001, 1012, 1223 ....

<<FULL TEXT>>

26 CFR 1.721-1: Nonrecognition of gain or loss on contribution.
(Also sections 722, 723, 1001, 1012, 1223, 7701; 1.1223-1, 301.7701-3.)

Disregarded entity to partnership. This ruling describes the federal
income tax consequences when a single member limited liability company
that is disregarded as an entity separate from its owner under section
301.7701-3 of the Procedure and Administration Regulations becomes an
entity with more than one owner that is classified as a partnership for
federal tax purposes.


REV. RUL. 99-5

ISSUE

What are the federal income tax consequences when a single member
domestic limited liability company (LLC) that is disregarded for federal
tax purposes as an entity separate from its owner under section 301.7701-3
of the Procedure and Administration Regulations becomes an entity with
more than one owner that is classified as a partnership for federal tax
purposes?


FACTS

In each of the following two situations, an LLC is formed and operates
in a state which permits an LLC to have a single owner. Each LLC has a
single owner, A, and is disregarded as an entity separate from its owner
for federal tax purposes under section 301.7701-3. In both situations, the
LLC would not be treated as an investment company (within the meaning of
section 351) if it were incorporated. All of the assets held by each LLC
are capital assets or property described in section 1231. For the sake of
simplicity, it is assumed that neither LLC is liable for any indebtedness,
nor are the assets of the LLCs subject to any indebtedness.

SITUATION 1. B, who is not related to A, purchases 50% of A's ownership
interest in the LLC for $5,000. A does not contribute any portion of the
$5,000 to the LLC. A and B continue to operate the business of the LLC as
co-owners of the LLC.

SITUATION 2. B, who is not related to A, contributes $10,000 to the LLC
in exchange for a 50% ownership interest in the LLC. The LLC uses all of
the contributed cash in its business. A and B continue to operate the
business of the LLC as co-owners of the LLC.

After the sale, in both situations, no entity classification election
is made under section 301.7701-3(c) to treat the LLC as an association for
federal tax purposes.


LAW AND ANALYSIS

Section 721(a) generally provides that no gain or less shall be
recognized to a partnership or to any of its partners in the case of a
contribution of property to the partnership in exchange for an interest in
the partnership.

Section 722 provides that the basis of an interest in a partnership
acquired by a contribution of property, including money, to the
partnership shall be the amount of the money and the adjusted basis of the
property to the contributing partner at the time of the contribution
increased by the amount (if any) of gain recognized under section 721(b)
to the contributing partner at such time.

Section 723 provides that the basis of property contributed to a
partnership by a partner shall be the adjusted basis of the property to
the contributing partner at the time of the contribution increased by the
amount (if any) of gain recognized under section 721(b) to the
contributing partner at such time.

Section 1001(a) provides that the gain or loss from the sale or other
disposition of property shall be the difference between the amount
realized therefrom and the adjusted basis provided in section 1011.

Section 1223(1) provides that, in determining the holding period of a
taxpayer who receives property in an exchange, there shall be included the
period for which the taxpayer held the property exchanged if the property
has the same basis in whole or in part in the taxpayer's hands as the
property exchanged, and the property exchanged at the time of the exchange
was a capital asset or property described in section 1231.

Section 1223(2) provides that, regardless of how a property is
acquired, in determining the holding period of a taxpayer who holds the
property, there shall be included the period for which such property was
held by any other person if the property has the same basis in whole or in
part in the taxpayer's hands as it would have in the hands of such other
person.


HOLDING(S)

SITUATION 1. In this situation, the LLC, which, for federal tax
purposes, in disregarded as an entity separate from its owner, is
converted to a partnership when the new member, B, purchases an interest
in the disregarded entity from the owner, A. B's purchase of 50% of A's
ownership interest in the LLC is treated as the purchase of a 50% interest
in each of the LLC's assets, which are treated as held directly by A for
federal tax purposes. Immediately thereafter, A and B are treated as
contributing their respective interests in those assets to a partnership
in exchange for ownership interests in the partnership.

Under section 1001, A recognizes gain or loss from the deemed sale of
the 50% interest in each asset of the LLC to B.

Under section 721(a), no gain or loss is recognized by A or B as a
result of the conversion of the disregarded entity to a partnership.

Under section 722, B's basis in the partnership interest is equal to
$5,000, the amount paid by B to A for the assets which B is deemed to
contribute to the newly-created partnership. A's basis in the partnership
interest is equal to A's basis in A's 50% share of the assets of the LLC.

Under section 723, the basis of the property treated as contributed to
the partnership by A and B is the adjusted basis of that property in A's
and B's hands immediately after the deemed sale.

Under section 1223(1), A's holding period for the partnership interest
received includes A's holding period in the capital assets and property
described in section 1231 held by the LLC when it converted from an entity
that was disregarded as an entity separate from A to a partnership. B's
holding period for the partnership interest begins on the day following
the date of B's purchase of the LLC interest from A. See Rev. Rul. 66-7,
1966-1 C.B. 188, which provides that the holding period of a purchased
asset is computed by excluding the date on which the asset is acquired.
Under section 1223(2), the partnership's holding period for the assets
deemed transferred to it includes A's and B's holding periods for such
assets.

SITUATION 2. In this situation, the LLC is converted from an entity
that is disregarded as an entity separate from its owner to a partnership
when a new member, B, contributes cash to the LLC. B's contribution is
treated as a contribution to a partnership in exchange for an ownership
interest in the partnership. A is treated as contributing all of the
assets of the LLC to the partnership in exchange for a partnership
interest.

Under section 721(a), no gain or loss is recognized by A or B as a
result of the conversion of the disregarded entity to a partnership.

Under section 722, B's basis in the partnership interest is equal to
$10,000, the amount of cash contributed to the partnership. A's basis in
the partnership interest is equal to A's basis in the assets of the LLC
which A was treated as contributing to the newly-created partnership.

Under section 723, the basis of the property contributed to the
partnership by A is the adjusted basis of that property in A's hands. The
basis of the property contributed to the partnership by B is $10,000, the
amount of cash contributed to the partnership.

Under section 1223(1), A's holding period for the partnership interest
received includes A's holding period in the capital and section 1231
assets deemed contributed when the disregarded entity converted to a
partnership. B's holding period for the partnership interest begins on the
day following the date of B's contribution of money to the LLC. Under
section 1223(2), the partnership's holding period for the assets
transferred to it includes A's holding period.


DRAFTING INFORMATION

The principal authors of this revenue ruling are Matthew Lay of the
Office of Assistant Chief Counsel (Passthroughs and Special Industries)
and Mark D. Harris of the Office of Associate Chief Counsel
(International). For further information regarding this revenue ruling
contact Mr. Lay at 202-622-3050 (not a toll-free call).

<<END RULING>>
 

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