LLC Tax Basis

The concept of “tax basis” is used to determine if any taxable disposition of property creates a realized and recognized gain or loss.  Tax basis is frequently the the amount of cash  a person has invested in a piece of property, which may be adjusted by several factors.  A tax is generally due on the sale or exchange of prperty if the sale exceeds the tax basis in the property transferred.

For an LLC with flow-through taxation, basis is a very important consideration.  Members of an LLC can deduct certain losses of an LLC allocated to them to the extent of their tax basis in the their LLC interest (subject to a few limitations).  A member’s tax basis can never be less than zero, even though it is not unusual to hear the term “negative basis” thrown around, which refers to a deficit capital account.

The tax basis of a member’s LLC interest equals the amount of cash and property, with adjustments, that the member contributes to the LLC.   The tax basis also includes any portion of the LLC’s liabilities, unless A) the debt is nonrecourse to that that member, but another member has personal liability for the debt, or B) the member is not at risk.

Accrued but unpaid expenses may be considered a liability that is allocated to ta member’s basis if the LLC uses anaccrual accounting method.  The IRS has also ruled that a short sale of securities is a liability that may increase each member’s tax basis.

A liability is considered recourse for tax purposes if any member or related person bears the economic risk of loss for that liability.  Each member’s share of the LLC’s recourse liabilities is based on that member’s economic risk of loss, so that generally a member bears the economic risk of loss to the extent that the member would be obligated to repay any of the LLC’s creditors without receiving reimbursement.  If a debt is recourse against all members, then each member’s share of the liability is included in their basis.

A nonrecourse liability is a debt for which the LLC member is not at risk or economic loss.  In this case, the basis attibuted to the debt is allocated to members according to their share of the LLC’s minimum gain, with any balance allocated to members according to their share of distributed profits.