Taxable Contributed Property Subject to a Liability

April 13, 2006

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Certain contributions made for ownership interests may be taxable events.

When the owner contributes assets subject to a liability (such as an outstanding mortgage) in exchange for an equity interest, this may be a taxable transaction. Here, the rules differ, depending on whether the contribution is to a limited liability company (LLC) or a corporation.

Generally, in the LLC or corporation, the owner's contribution will be taxable if the amount of the liability assumed by the entity exceeds the owner's tax basis in the asset contributed. In the corporation, the liability is subtracted from the owner's basis in the asset contributed, to derive the tax basis of his ownership interest. In the LLC, the liability assumed by the LLC affects the tax basis of each owner in the LLC.

Different rules also apply in the case of the corporation, when there is a contribution of property and the transferors do not control 80 percent or more of the corporation.

These other rules could apply, for example, to subsequent contributions to a corporation by a single transferor who, alone, controls less than 80 percent of the corporation. Here, when property is contributed to a corporation subject to a liability, or non-cash property is contributed, gain is recognized on the contribution, as if the property were sold to the corporation. In this case, no basis adjustments are required for the liability. Instead, the corporation picks up the asset on its books at fair market value (along with the liability) as if it had purchased the asset.

Warning

Clearly, these calculations are complicated. Professional guidance should be sought before property subject to a liability is contributed to an LLC or a corporation.