I received a question at USTaxAid.com regarding the sale of an LLC interest. The basis in the LLC was zero and so the question asked how the sale would be taxed.
It sounds like an easy question, but there are actually a number of things to consider. If you’re selling a business, there are a couple of basic things you may be selling. You may be selling the assets, or as in this case, you may be selling all or part of the equity.
If you sell the assets, you’ll pay the highest ordinary tax rate for most of the gain. If you sell the equity, you’ll pay the lower capital gains tax rate. So far, so good for the seller of the LLC interest. His highest federal tax rate would be 20%, instead of 39.6%
He also said that his LLC basis was zero. There are a couple of reasons why this might be the case.
- He may have not contributed anything when the LLC was begun,
- He might have taken all of his basis out through distributions, or
- The LLC might have experienced losses that wiped out the capital contributions.
The amount of basis is an important calculation now that he’s selling and it’s been an important calculation while he held the interest. If there is a loss, you need to have basis in order to take the deduction. If the value of the investment is zero, I bet that means he’s had some unused carryforward losses. If that’s the case, they will be added to basis when the interest is sold.
As an example, let’s say that his initial basis came from a contribution of $20,000. His share of losses have been $50,000 over the years. But, because his basis was only $20,000, that’s all he’s been able to deduct on his tax return. The other $30,000 is just left as a suspended, carryover basis. And it’s carried over to now! In our hypothetical case, he now sells his interest for $60,000. His gain will be $30,000, or $60,000 minus $30,000. That gain is then subject to capital gains tax, which might range anywhere from 0% – 20%.
My example has been simple here. There are actually two different ways you might have basis. One is because of equity in the business, as we’ve discussed here. The second is due to debt. If you’ve loaned money to the LLC, or you have signed as a personal guarantor to the LLC, that counts as debt equity. Again, the importance of this is because it means you’ll get to take tax advantage of losses you have through the LLC.