| Generally, the LLC and its members do not recognize | | | | outside basis or when an LLC with "hot assets" makes |
| gain or loss on a distribution of cash or property. Gain | | | | a non-pro rata distribution. In general, "hot assets" are |
| or loss would only be recognized when deferral is | | | | defined as unrealized receivables or inventory of the |
| impractical or when it would result in a change of | | | | LLC. However, when an LLC distributes property to a |
| character. It is extremely important to have an LLC | | | | member, the inherent gain or loss in the member's |
| Operating Agreement so that the manner in which | | | | interest can be preserved by adjusting the basis of the |
| cash will be distributed to the members is well | | | | distributed property. |
| documented. | | | | RECOGNITION OF LOSS |
| Internal Revenue Code Section 731 provides for | | | | A member recognizes a loss only in a liquidating |
| nonrecognition of gain or loss to all parties when LLC | | | | distribution, and then only under certain circumstances. |
| property or money is distributed. In the case of a cash | | | | A loss is never recognized in a current (non-liquidating) |
| distribution, the distributee simply reduces his/her | | | | distribution. In a situation where a liquidating distribution |
| outside basis by the amount of money received, | | | | consists only of cash, unrealized receivables and |
| preserving any inherent gain or loss in his/her LLC | | | | inventory, the distributee will recognize a capital loss if |
| interest. A member's initial outside basis equals the | | | | his/her outside basis exceeds the sum of money |
| amount of cash the member contributes to the LLC, | | | | distributed plus the basis he/she takes in the distributed |
| the basis the member had in any property contributed, | | | | property. This is because, in this situation, the distributee |
| and the member's share of the LLC's debt. | | | | receives no capital asset in which to defer the loss. |
| In the case of a property distribution, the distributee's | | | | For example: Steve has an outside basis of $150 in his |
| outside basis is allocated among both the property or | | | | LLC interest. In a liquidating distribution, Steve receives |
| properties received and his/her continuing interest in | | | | $75 cash and accounts receivable with a basis and |
| the LLC (if any). Any pre-distribution inherent gain or | | | | value of $50. Steve has sustained a $25 loss from the |
| loss in the distributee's LLC interest is preserved either | | | | LLC interest. The loss cannot be deferred in the cash, |
| in the property received or in his/her continuing interest | | | | but could be deferred by giving Steve a basis in the |
| in the LLC. Gain or loss is recognized only when | | | | accounts receivables of $75. This would produce a |
| deferral is impractical or would change the character | | | | $25 ordinary loss when the receivables are collected. |
| of income or loss. | | | | To prevent Steve from converting his capital loss into |
| RECOGNITION OF GAIN | | | | an ordinary loss, Steve is required to recognize the |
| Distributions generally trigger a gain if a member | | | | capital loss at the time of the distribution. |
| receives a distribution of money in excess of his/her | | | | |