Take Care Closing Down An LLC – IRC 752 – Treatment of Certain Liabilities

A taxpayer reading one of my blog posts from Ishpeming, Michigan was compelled to call me today. She was a member in a Limited Liability Company (LLC) who had ultimately resigned herself to abandoning her interest in the LLC.

In advance of the call she faxed me a 2011 K-1 with a negative capital account as well as allocated non-recourse liabilities and a final 2012 Schedule K-1 from the partnership with $0, nada, nilch reported for both income or deductions. Evidently there was no 2013 K-1 produced.

Random calls like this routinely come in from all over the planet and every opportunity to revel in the distractions is appreciated this time of year. She began the conversation by seeking confirmation that she could claim a loss in the abandonment effort for her original investment or basis.

YIKES! Having a kind soul I tend to spend the first 30 minutes of time meeting someone new as a non billable gratis service but I sensed that this was going to get more involved because what I had to tell her she did not want to hear or simply could not hear.

Basically in situations like this you may have a gain to report because LLC members can indeed have reductions in individually allocated nonrecourse liabilities deemed a distribution or even considered a gain on a deemed sale when abandoning their interest.

This is where it can be difficult for the layperson to understand … liabilities categorized as nonrecourse means that the member is not liable for the debt which in this file is irrelevant for IRC §752 purposes because accordingly increases in allocated liabilities of most any partnership are treated as though they are the opposite of capital contributions and decrease basis. One the same note, §752 treats reductions in allocated partnership liabilities as distributions meaning that if an LLC member reduces an allocation in liabilities year over year it can be deemed a distribution and treated as a gain upon disposition OR abandonment.

In making this determination because capital accounts can be different from basis calculations, you are best served calculating basis first and then comparing it to any “deemed” distribution caused by a reduction of liabilities with any difference attributed to gain. The really hard part for most taxpayers is that this is true even if no actual cash is received and usually abandonment does not involve a transaction per se.