Sole Proprietorship to a Multi-Member LLC
Lynda Gruling (Controller, D&K Pallets)
| Mar 26, 2010We are in the process of converting from a Sole Proprietorship to a Multi-Member LLC. My question is how do I establish the equity and tax basis for each member? How are the assets recorded? At market value, cost, or at depreciated book value on the proprietorship books? Thank you for any insight on this.
Answers
Company: Malkani Advisory
On conversion it is usual for all assets to be recorded at fair market value. The logic for this is that it is "fair" to all. To achieve that the sole proprietorship would revalue all assets and the gain or loss would impact the sole proprietor's capital account. Each new member would contribute assets as fair market value and their capital account would reflect the net assets contributed again at fair market value.
Company:
I would look at FMV (replacement cost) and use method of adding partners under GAAP.
Bonus method where new partner pays a bonus or receives a bonus based on agreements.
Goodwill method where a member has goodwill they bring to LLC.
Based on FMV of LLC at time of agreement.
Bob
Company: First Priority, Inc.
Be careful here - as a general rule, the TAX basis of the proprietor's assets carries over into the LLC, and proprietor has no taxable gain or deductible loss upon making the capital contribution. Special allocations of depreciation expense can be utilized to help achieve "fairness". Assumption of liabilities in excess of tax basis of contributed assets changes this result.
Company:
Yes, your right. I was just using the method of allocating another member. Generally it all depends on if there is GW or bonus paid to new members. Otherwise depending on ownership position % would determine teir respective basis.
Is this clearer?
Company: D&K Pallets
To make sure I am understanding correctly, the proprietor's assets carryover at tax basis. Then allocate to equity according to ownership %?
Company: First Priority, Inc.
Generally, proprietor's initial tax capital account will be equal to his tax basis in contributed assets. Assume a 50/50 partnership, proprietor contributes assets with basis of $10 and FMV of $50. Other partner contributes $50 in cash. Tax capital accounts are $10 and $50, respectively. Tax balance sheet consists of $50 cash; $10 other assets; and $60 partner capital.
I think you'll need to study Internal Revenue Code Section 704 and the underlying regulations to get into specifics on the nuances of equaling them out. You may need to call in a partnership tax guru - especially if the numbers are significant.
Perhaps the attorney that drafted the LLC operating agreement can assist.