Technical Termination of a Partnership
If you are a partner in a partnership or a member of an LLC that is treated as a partnership, and there is a change of fifty percent (50%) or more of the capital and profits in a twelve month period, the Internal Revenue Service requires that entity to “technically terminate” as of the occurrence date and reform a new partnership. If properly handled using the provisions of IRS code section 721, there is generally no tax consequence to this “technical termination.” However, income (losses) may not always be allocated based on the previous profit/loss sharing or ownership percent.
When a new partner contributes assets other than cash, such as appreciated property, the tax basis within the partnership will continue to be the same as the amount as if it were still in the hands of the contributing partner. This will occur even though the amount being credited to the partner’s capital account may be the fair market value of the property on the date of contribution.
In order to prevent possible abuses and inequities in the allocations of certain gains or losses caused by those differences, the cost basis and fair market value will be specifically allocated to the contributing partner via IRS code section 704(c).
It is extremely important to consult with your tax advisor if you are contemplating a change of 50% or more of a partnership interest.