ACCOUNTING 367
FACTS
The taxpayer is multi-member entity, with each member holding a 50% membership
interest. The taxpayer is primarily engaged in the purchase and sale of fine artistic pieces. The
LLC intends to make a non-liquidating distribution of three (3) paintings, which are all held as
inventory. Following the distribution, the distributee-member(s) intend to give an inter-vivos gift
of the distributed inventory property to their daughter. The taxpayer is taxed as a partnership under
the Internal Revenue Code (“IRC”), Subchapter K. In anticipation of the distribution and gift, we
have researched the following issues related to any potential for recognition of income, gain or
loss which would result from such distribution.
I SSUES
1.Discuss Whether a non-liquidating distribution of inventory by an LLC to its member(s),
would result in the recognition of gain or loss?
2. What are the tax consequences to the distributee-partner(s) and the donee of an inter-
vivos gift of previously distributed inventory?
CONCLUSION
1. Under IRC §731, an LLC and its members generally do not recognize gain or loss upon
the distribution of property to a member. Under IRC §751(b) however, an LLC and its
members will recognize gain or loss following the non-liquidating disproportionate
distribution of substantially appreciated inventory. The rules under §751(b) do not apply
to pro-rata distributions. In order to avoid the recognition of gain or loss under §751(b),
the LLC should make a pro-rata distribution of substantially appreciated inventory to all
members. The LLC and distributee-member(s) should but are not required to submit a
statement with the tax return for the year of the distribution, showing the computation of
income, gain, or loss resulting from the distribution.
2. If the distributee-member subsequently makes an inter-vivos gift of the distributed
property, the distributee-member may be subject to gift tax consequences. A donor is
subject to the gift tax, as computed under IRC §2501, on all gifts which exceed the
annual gift exclusion under §2503(b). The annual gift exclusion amount under §2503 is
$13,000.
The donor-members can thus gift away property valued at $13,000 to any
beneficiary without being required to file a gift tax return. If the gift is valued above
$13,000, a gift tax return must be filed.
Under IRC §102(a), no gain or loss is recognized by the donee on an inter-vivos
gift of property. The donee will realize the inherent gain or loss in the gifted property
upon a subsequent disposition of the property. Under §735(c)(2)(A), the character of the
donee’s gain or loss on the sale or exchange of §751 property will be ordinary if
disposed of within 5 years from the date of the distribution. The ordinary income “taint”
on the distributed inventory dissipates five (5) years after the distribution. In order to
avoid the recognition of ordinary gain or loss under §735(c)(2)(A), the donee should wait
five (5) years from the date of distribution to dispose of the distributed property.
