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Business Law: Certain Tax Benefits and Business Arrangements Available Only if Spelled Out in the Governing Agreement

If you are a member of an LLC taxed as a partnership or a partner of a partnership, you may be able to revalue the property of the LLC or partnership upon the occurrence of certain events, but you must have certain provisions in your operating agreement or partnership agreement to do so.

Such revaluation would allow the entity to adjust the capital accounts of the owners to track properly the economic agreement of the owners and prevent unintended tax consequences. If you as an owner fail to do so, some potential adverse consequences include not being able to make depreciation deductions or receiving an incorrect amount of compensation upon withdrawal from the entity. 

The events upon which a revaluation of property may occur include:  (i) a contribution of money or other property (other than a de minimis amount) to the entity by a new or existing owner as consideration for an interest in the entity; (ii) the grant of an interest in the entity (other than a de minimis interest) as consideration for the provision of services to or for the benefit of the entity by an existing owner acting in an ownership capacity, or by a new owner acting in anticipation of being an owner; or (iii) the liquidation of the entity or a distribution of money or other property of the entity (other than a de minimis amount) to a retiring or continuing owner as consideration for an interest in the entity.

The provisions you must include in the operating agreement or partnership agreement are that: (i) the adjustments to the capital accounts will be in accordance with Treasury Regulation 1.704-1(b)(2)(iv)(g) for allocations to the owners of depreciation, depletion, amortization, and gain or loss, as computed from the book value of the revalued property; and (ii) the owners’ distributive shares of depreciation, depletion, amortization, and gain or loss, as computed for tax purposes, with respect to the revalued property be determined so as to take account of the variation between the adjusted tax basis and book value of such property in the same manner as under Section 704(c) of the Internal Revenue Code. 

There are additional requirements that the entity must satisfy to qualify for the adjustments, so you should consult with your attorney and accountant to determine whether you may benefit from amending your operating agreement or partnership agreement to include the requisite provisions.

For more information please contact William G. Sturm at 410-583-2400 or sturm@bowie-jensen.com.

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