Can the members of a Colorado LLC claim the Colorado source capital gain subtraction on the gain from selling all the LLC's business assets, mostly goodwill?

Plain-English summary

A Colorado LLC ran a private laboratory and, in 2008, sold all of its business assets to an unrelated buyer (with installment payments through 2010). About 94% of the price was goodwill — an intangible asset. The LLC and its members hadn't claimed the Colorado source capital gain subtraction at the time because guidance was thin, and now wanted to amend their 2008–2010 returns to claim it. The Department said no.

Colorado's capital gain subtraction (§ 39-22-518) lets a qualified taxpayer subtract certain Colorado-source capital gains from taxable income, but only in two defined buckets:
- (A) gain on real or tangible personal property located in Colorado; or
- (B) gain on the sale of stock, or an ownership interest, in a Colorado company / LLC / partnership acquired on or after May 9, 1994 and held at least five years.

The goodwill gain fails both. It isn't (A), because goodwill is intangible property, not real or tangible personal property — and the Department reads the legislature's omission of intangibles from subsection (A) as deliberate. And it isn't (B): the members argued that selling all the LLC's assets is economically the same as selling an "ownership interest," but the Department disagreed. An "ownership interest" means a member's interest in the company (its membership/partnership interest), which is distinct from the company's own interest in its assets. When the LLC sells its assets, title passes from the company; no member sells a membership interest.

The Department gave the taxpayer real credit — it walked through four "substantial arguments" in the taxpayer's favor (the business was effectively sold; goodwill of a Colorado company is hard to site anywhere but Colorado; federal law sometimes equates asset and stock sales; and statutes should track economic reality). But it landed on the statute's structure and on how the transaction was treated federally. The sale was an asset sale, not a stock sale under a 26 U.S.C. § 338 election (which isn't even available to entities not taxed as corporations), and federal treatment controls the Colorado result. Treating it as an ownership-interest sale would also collapse the deliberate line between subsections (A) and (B) and would, oddly, let a company subtract gain on selling a single important intangible (like one copyright). The conclusion is consistent with FYI Income 15, where the Department disallows the subtraction on a sole proprietor's sale of goodwill.

What this means for you

Owners selling a Colorado business

How you structure the sale matters for this subtraction. Selling the entity — your membership or partnership interest (or corporate stock) held five-plus years — can qualify under subsection (B), and that price indirectly captures goodwill value. Selling the assets of the business does not, except to the extent the assets are Colorado real or tangible personal property; gain attributable to goodwill and other intangibles in an asset sale gets no subtraction. If the capital gain subtraction is important to you, weigh an interest sale against an asset sale before you sign.

Sellers of goodwill specifically

Goodwill is intangible, so its gain never qualifies under the "real or tangible personal property" bucket, and an asset sale doesn't convert it into an "ownership interest" sale. The same disallowance applies to a sole proprietor's goodwill (FYI Income 15).

Accountants and tax professionals

The holding turns on (1) the statute's two distinct buckets and the deliberate exclusion of intangibles from (A); (2) "ownership interest" meaning the member's interest in the entity, not the entity's interest in its assets (§ 7-80-702(1)); and (3) federal treatment controlling — an asset sale without a § 338 election stays an asset sale for Colorado. Note also the five-year holding and "Colorado company" (≥50% payroll and property in Colorado) requirements for the subsection (B) route.

Common questions

Q: Can I subtract the gain from selling my Colorado business's assets?
A: Only the portion attributable to Colorado real or tangible personal property. Gain on goodwill and other intangibles in an asset sale does not qualify for the Colorado source capital gain subtraction.

Q: Isn't selling all the assets basically selling the company?
A: Economically similar, but legally different, and the Department treats them differently. The subtraction's "ownership interest" route requires selling the membership/partnership interest or stock — not the company's assets.

Q: Would selling my LLC interest instead have qualified?
A: Potentially, under subsection (B), if the interest was in a "Colorado company," acquired on/after May 9, 1994, and held at least five years. This ruling addressed an asset sale, which doesn't meet that test.

Q: Why does the ruling mention sales and use taxes?
A: That closing line is a boilerplate copy-paste error. PLR 12-008 is an income-tax ruling about the capital gain subtraction; the sales/use-tax language doesn't reflect its substance.

Citations and references

Statutes, rules, and guidance:
- § 39-22-518, C.R.S. (Colorado source capital gain subtraction), incl. (2)(b)(I)(A) and (B)
- 26 U.S.C. § 1222(11) (net capital gain); 26 U.S.C. § 338 (stock-sale-as-asset-sale election)
- § 7-80-702(1), C.R.S. (LLC membership interest is personal property, distinct from the LLC's assets)
- Treas. Reg. § 301.7701-3 (single-member LLC disregarded)
- FYI Income 15 (Colorado Capital Gain Subtraction) — disallows subtraction on a sole proprietor's goodwill sale

Source

• Landing page: Colorado All Letter Rulings
• Original PDF: PLR-12-008.pdf

Original ruling text

Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]

PLR-12-008

December 31, 2012

xxxxxxxxxxxxxxxxxxxxx
ATTN:XXXXXXXXXXXXXXXX
xxxxxxxxxxxxxxxxxxxxx
xxxxxxxxxxxxxxxxxxxxx
Re: Private Letter Ruling

DearXXXXXXXXXXXXX,
You submitted on behalf of XXXXXXXXXXXXX ("Taxpayer") a request for a private
letter ruling to the Colorado Department of Revenue ("Department") pursuant to
Regulation 24-35-103.5. This letter is the Department's private letter ruling.
Issue
Can Taxpayer and its members amend their 2008-2010 individual Colorado income
returns to exclude the net capital gain resulting from the sale of the Taxpayer's
business assets?
Conclusion
Taxpayer and its members cannot amend their 2008-2010 individual returns to exclude
the net capital gain resulting from the sale of the Taxpayer's business assets.
Background
Taxpayer is a LLC formed to develop, own, and operate a private laboratory located in
Colorado. Taxpayer did not own any property or other assets outside of Colorado. In
2008, Taxpayer sold its assets to an unrelated company ("Buyer"), which has
continued this Colorado business under the same name, at the same location, and has
invested substantial funds in the business to expand and update the laboratory,
equipment, and to employ additional personnel.
To effectuate the sale, Taxpayer entered into an Asset Purchase Agreement. Taxpayer
transferred all rights, title, and interest and all assets of every kind or type, tangible or
intangible, real or personal that were necessary or desirable to operate Taxpayer's

business. Taxpayer retained ownership of certain corporate and financial records, cash
in excess of $500,000, and incidental assets of a personal nature to Taxpayer or its
members and not used in the business. Taxpayer received installment payments for
the Asset Purchase Agreement in 2008, 2009, and 2010.
Taxpayer represents that this sale meets all the holding period and other requirements
of the Colorado Source Capital Gain Subtraction ("Subtraction"). Taxpayer states there
is limited published guidance from the Department as to how the Subtraction is to apply
to a business sale of substantially all the assets of the business compared to a sale of
the ownership interests in the business. Given the lack of guidance, the Subtraction
was not claimed on the 2008, 2009, and 2010 Colorado income tax returns filed by
Taxpayer and its members. However, Taxpayer and its members now desire to amend
their returns to claim and report the Subtraction.
Discussion
Colorado taxpayers can reduce their Colorado taxable income that is treated at the
federal level as capital gains derived from (1) the sale of real or tangible personal
property located in Colorado, or (2) the sale of stock or an "ownership interest" in a
Colorado company. Specifically, §39-22-518, C.R.S. provides, in pertinent part:
(1)

(2)

[A qualified taxpayer is allowed] a reduction of income taxable by the state of
Colorado ... for the amount of income attributable to qualifying gains receiving
capital treatment earned by the qualified taxpayer during the taxable year and
included in federal taxable income.
(b)(l)"qualifying gains receiving capital treatment" means the amount of net
capital gains, defined in section 1222(11) of the internal revenue code, included
in any qualified taxpayer's federal taxable income and:
(A) Earned by the qualified taxpayer on real or tangible personal property
located within Colorado... ; or
(B) Earned on the sale of stock or on the sale of an ownership interest in a
Colorado company, limited liability company, or partnership where the
stock or ownership interest was acquired on or after May 9, 1994, and that
has been held by the qualified taxpayer for a holding period of at least five
years prior to the date from which the capital gains arise ... (emphasis
added)

In 2008, Taxpayer sold all of its assets to Buyer and ceased its management, control,
and ownership of its enterprise. Taxpayer continued as a partnership after 2008, but
only for the purpose of collecting installment payments paid in 2009 and 2010. The
principal asset sold by Taxpayer was its goodwill, which was approximately ninety-four
percent of the purchase price. Income from this sale of the goodwill qualified for capital
gain treatment under 26 USC §1222(11).1 We agree with Taxpayer that this capital
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Taxpayer represents that the income from the sale of goodwill is properly treated as capital gains
pursuant to 26 USC §1222(11). Income from the sale of goodwill can qualify capital gains under
§1222(11) and Taxpayer appears to have held the property for the requisite period for purposes of the
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gain does not qualify under subsection (A) because goodwill is neither real property nor
tangible personal property. However, Taxpayer requests the Department treat the sale
of its assets as a sale of an "ownership interest" under subsection (B).
We begin with a review of the statutory language, both in terms of the language used
and the organization of the statutory provisions. The legislature defined two large
categories (subsections A and B) of capital gains that qualify for the Subtraction. The
first is comprised of two of the three most familiar forms of property: real property and
tangible personal property. Notably absent in subsection (A) is the third of the most
common forms of property: intangible property. This obvious omission suggests the
legislature intended the Subtraction to not extend to a variety of intangibles, such as
goodwill. Intangible property is traditionally defined as conceptual in nature and
includes such things as patents, copyrights, tradenames, trademarks, franchise rights,
licenses, contract rights, claims of action, stocks, ownership interests, and goodwill,
among many others. Goodwill is universally recognized as an intangible property right.
Subsection B addresses intangibles eligible for the Subtraction. Of the many types of
intangible property we list above, the legislature identified only two that qualify for the
Subtraction: stock in corporations and ownership interests in partnerships and limited
liability companies.2
We note, however, that the exclusion of intangibles (other than stock and ownership
interests) from the Subtraction is not as absolute as would first appear. The value of a
stock or an ownership interest likely reflects the value of intangibles owned by a
company (e.g., patents, goodwill). Thus, a Colorado taxpayer does receive, albeit
indirectly, a subtraction for goodwill when the taxpayer sells stock or an ownership
interest. However, this untidiness in excluding intangibles may not be so much a
reflection of legislative intent to include intangibles, such as goodwill, as it is a
reflection of the difficulty, if not impossibility, of drafting legislation that in all respects
perfectly effectuates legislative intent.3
We next consider Taxpayer's specific argument that the sale of all a company's assets
is, as a matter of economic reality, the same as a sale of an "ownership interest." This
is a close question. We believe that there are four substantial arguments in favor of
Taxpayer's argument. First, Taxpayer has, as both an economic and operational
matter, sold a business enterprise to Buyer. Taxpayer itself no longer has an active
business enterprise: its sole function appeared to be to collect the final installment

Subtraction. The Department presumes Taxpayer's representation is correct for purposes of addressing
the issue raised in this ruling request, but the department does not determine here whether the
representation is correct.
2
Subsection (B) of 39-22-518(2)(b)(I), C.R.S.
3
Indeed, this sloppiness in line-drawing also works in the other direction. For example, the value of stock of
a Colorado company may reflect the value of a company's recent acquisition of a copyright, which,
because the copyright was recently acquired, may not itself qualify for capital gains treatment.
Nevertheless, the sale of the stock, including the value of the copyright, will qualify for the deduction if the
sale of stock qualifies for capital gain treatment.
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payments due under the purchase agreement. Thus, as Taxpayer argues, the
business enterprise has been effectively sold.
Although not an argument advanced by Taxpayer, the second argument relates to
what may have been one of the principal goals of this Subtraction. The legislative
declaration for the Subtraction does not explain why some intangibles are included and
some are not. One explanation may relate to the legislature's apparent interest in
limiting the subtraction to those assets that are physically located in Colorado. And,
unlike the situs of real and personal property or the commercial operations of
corporations and other entities, the situs of intangible personal property is more a
matter of policy than it is of fact. If the legislature intended the Subtraction to be limited
to those that arise in Colorado,4 then the legislature may have excluded intangibles to
ensure that only those gains that can be readily traceable to Colorado sources are
included in the Subtraction. For this reason, the legislature may have permitted stock
and ownership interests to be included in the subtraction if the company itself is located
in Colorado. Allowing a deduction for the sale of goodwill in this case seems
consistent with the apparent legislative intent to limit the capital gain deduction to those
assets located in Colorado. Taxpayer is located in Colorado and its goodwill cannot be
said to have a situs other than in Colorado.
Thirdly, Taxpayer observes that the IRS has gone to some length to remove
differences in the tax treatment of the sale of a business enterprise through a stock
sale versus a sale of its assets.5 Pursuant to 26 USC §338, a taxpayer whose
commercial enterprise is sold via a stock sale will be treated, for tax purposes, as if the
company sold its assets. However, it is important, we think, to note here that this was
accomplished only by the specific enactment of §338, and that this treatment is only
available in limited circumstances and upon the specific election of the taxpayer. In the
absence of such a provision and election, the tax outcome at the federal level for an
asset sale is quite different from the sale of stock. Taxpayer did not conduct its sale
pursuant to §338 and, as discussed below, the tax treatment at the federal level will
govern the treatment at the state level.
It is also important to note that, although the two types of transactions may be
economically similar, there are important differences between these two transactions
(asset sale v. stock sale). In the former case, only assets of the company are sold; in
the later case, ownership of the entity itself is sold, not its assets. In the latter case, the
buyer is, among other things, purchasing liabilities of the company, including contract
and tort liabilities, contractual obligations, regulatory compliance issues, among many
In order to qualify for the Subtraction, the real or personal property must be "located in Colorado" and the
stock or ownership interest must be of a "Colorado company, "which is a company that has at least fifty
percent of its payroll and property assigned to Colorado." §39-22-51B(b)(l)(A), (B) and (b)(ll)(A), C.R.S.
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See, generally, §338, I.R.C. which allows the company acquired by stock to have a stepped-up basis in
its assets. A similar approach is arguably used for single member limited liability companies. The sale of
goodwill of a single member limited liability company will not qualify for the Subtraction because the
single member LLC will be disregarded for federal tax purposes when, as here, its members are
individuals and be treated as a sole proprietorship. IRS Proc.&Admin.Regs. § 301.7701-3

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others. As noted below, treating the sale of the Company as a sale of ownership
interest rather than a sale of assets is inconsistent with the realties of the transaction.
Finally, we also acknowledge that, where possible, we interpret statutes governing
income tax in such a fashion as to recognize the economic realities of transactions.
General Motors Corporatio v. Franchise Tax Board, 139 P3d 1183 , 47 Cal.Rptr.3d
233 (2006). These arguments are compelling arguments and may reflect sound policy.
However, we conclude that in order to reach such a result we must expand the
interpretation of "ownership interest" beyond how this term is generally understood.
"Ownership interest" is not explicitly defined in the tax statutes. However, a similar
term is used in the Colorado statutes governing limited liability companies.6 There, a
"membership interest" means a member's share of the profits and losses of a limited
liability company and the right to receive distributions of such company's assets. A
membership interest is, itself, personal property and is distinct from the limited liability
company's ownership interest in the assets.7
We think "ownership interest" is a slightly broader term that encompasses not only
membership interests in a limited liability company but also partnership interests in a
partnership. As in the case of a membership interest in a limited liability company, a
partnership interest in a partnership is personal property, is saleable, and must, itself,
qualify for capital gains treatment regardless of how the real and tangible assets,
whose value is reflected in these interests, qualify for capital gains treatment.
Moreover, title to assets of a partnership or limited liability company is held in the name
of the company, not in the name of its partners or members. Thus, when a partner or
member sells its membership interest, title to the assets does not pass from seller to
buyer. In the present case, members did not sell their membership interests to Buyer;
rather, members sold title to the assets passed from Taxpayer to Buyer.
More importantly, construing the sale of a business enterprise by means of its assets
as a sale of an ownership interest is inconsistent with the way the transaction is viewed
at the federal level and how the parties treated the sale. Although the IRS has, as
noted above, eliminated disparate tax treatment of asset and stock sales under 26
USC §338, the sale at issue was not made pursuant to 26 USC §338 because a 26
USC §338 election is not even available to entities that are not taxed as corporations.
How the transaction is handled at the federal level is important because it controls how
the transaction is treated for Colorado's income tax purposes. For example, in the sale
of assets, the buyer receives a stepped-up basis in the assets and the seller receives
capital gains treatment of the income. The buyer does not receive a stepped-up basis
if it purchases the membership interests.
6
7

Title 7, article 80, C.R.S.
7-80-702(1), C.R.S. "(1) The interest of each member in a limited liability company constitutes the personal
property of the member and may be assigned or transferred. Unless the assignee or transferee is admitted
as a member, the assignee or transferee shall only be entitled to receive the share of profits or other
compensation by way of income and the return of contributions to which that member would otherwise be
entitled and shall have no right to participate in the management of the business and activities of the
limited liability company or to become a member."
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In addition, it is not clear to us that the Taxpayer's approach reflects the realities of the
transaction. There are substantial practical and commercial differences between the
sale of assets and the sale of an ownership interest in a company. For example, an
asset sale by-passes dissident members who object to a sale and allows the buyer to
avoid the assumption of contractual, tort, and regulatory liabilities of the company. In
the present case, Taxpayer opted to sell its assets rather than have individual
members sell their membership interests.
As with all transactions, the avenue selected by the seller and buyer will have
advantages and disadvantages depending on the form chosen. We think it
inconsistent with both federal tax treatment and the intentions of the parties to treat the
sale of assets as a sale of an ownership interest at the federal level, and then construe
the sale as a sale of member's membership interest at the state level.
Taxpayer's argument also leads to results that are unusual. The thrust of Taxpayer's
argument is that the sale in this case is a sale of an ownership interest because all
assets are sold. However, subsection (B) does not require all ownership interest to be
sold in order to qualify for the Subtraction. This subsection applies even if only some
ownership interest is sold. It is unclear why, under this rationale, the Subtraction would
not be available to, for example, a publishing company that sells an important copyright
through which it engages in a substantial enterprise. It is difficult to see why a
corporation's sale of the copyright does not qualify as a sale of an "ownership interest"
in that line of business. Such an approach essentially undoes any distinction between
subsections (A) and (B) - a result that we believe is not permitted.
Finally, we note that our conclusion here is consistent with prior advice on a related
transaction. In FYI Income 15 (Colorado Capital Gain Subtraction), the Department
states that it will disallow the subtraction for the sale of goodwill by a sole
proprietorship. A sole proprietor does not have an ownership interest in a company,
limited liability company, or partnership separate and apart from its ownership interest
in the assets. As noted above, the sale of a company, limited liability company, or
partnership's ownership interest in assets is not the same transaction as the sale of a
company, limited liability company or partnership's ownership interest. In other words,
the sale of all the assets of a sole proprietorship does not constitute the sale of an
"ownership interest" in a company, limited liability company, or partnership.
In sum, we conclude that "ownership interest" must be interpreted to mean the sale of
member's interest in the limited liability company, and does not include the sale by the
limited liability company of its assets.
Miscellaneous
This ruling applies only to sales and use taxes administered by the Department. Please
note that the Department administers state and state-collected city and county sales
taxes and special district sales and use taxes, but does not administer sales and use
taxes for self-collected home rule cities and counties. You may wish to consult with
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local governments which administer their own sales or use taxes about the applicability
of those taxes. Visit our web site at www.colorado.gov/revenue/tax for more
information about state and local sales taxes.
This ruling is premised on the assumption that Company has completely and
accurately disclosed all material facts. The Department reserves the right, among
others, to independently evaluate Company's representations. This ruling is null and
void if any such representation is incorrect and has a material bearing on the
conclusions reached in this ruling. This ruling is subject to modification or revocation in
accordance to Department Regulation 24-35-103.5.
Enclosed is a redacted version of this ruling. Pursuant to statute and regulation, this
redacted version of the ruling will be made public within 60 days of the date of this
letter. Please let me know in writing within that 60 day period whether you have any
suggestions or concerns about this redacted version of the ruling.
Sincerely,

Office of Tax Policy
Colorado Department of Revenue

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