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PostHeaderIcon Buying or Selling a Business – Technical Terminations

A few months ago, I discussed the differences between a stock sale and an asset sale.  In one of the examples, I touch on technical terminations and this concept deserves it’s own post.  Let’s start with an example.

Two friends set up an LLC and buy a piece of real estate with each owning 50% of the LLC,  The company files partnership returns (Form 1065) for several years, buys several new pieces of real estate and ten years later, it holds an apartment building, a commercial property and ten single family residences.  One partner decides he wants to go in another direction so he finds a buyer for his 50% interest, the sale is made, the old partner computes his gain on the sale and the new partner just steps into the old partner’s shoes, right??

Wrong

Code section708(b)(1) discusses two ways that a partnership terminates.  The first way is if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership.  So if the partnership isn’t doing anything, it no longer exists.  The other way that a partnership is terminated is if within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.  That means in our example, the partnership has terminated and this has been called a technical termination because the partnership really continues to operate.

What does this mean?  First off, the partnership will have to file two tax returns in that one calendar year (assuming one technical termination).  If in our example the sale of the partnership happened on June 30, then you have a short period return going through June 30 with all of the normal due dates and then a second tax return from July 1 through the end of the year.

Second, depreciation starts over.  If you have commercial property that you bought for $1 million and over 20 years it’s depreciated, when the technical termination happens, then the new partnership’s cost basis would be the old partnership’s net taxable value (in this case, around $500,000).  The bad news is, the useful life resets so you’d then begin depreciating that $500,000 over a “new” 39 years.

In short, if you’re selling a partnership interest, talk to someone who knows partnerships.  You could do some planning to avoid a technical termination although even if you do fall into one, you have to know what to do with the short period tax returns.

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