Did contributing Texas real estate to a partnership and liquidating two single-member LLCs change their taxable earned surplus when federal law recognized no gain or loss?

Plain-English summary

The property contribution and LLC liquidations did not change taxable earned surplus if the relevant federal tax computations recognized no gain or loss.

Two Virginia single-member LLCs owned Texas commercial real estate. LLC 1 was owned by a revocable grantor trust whose grantors reported the trust's income and deductions. LLC 2 was owned by a limited partnership and was presumed federally disregarded.

The LLCs planned to contribute their Texas real estate to a new Virginia limited partnership in exchange for a combined 99% limited-partnership interest. They would then liquidate and distribute that partnership interest to their owners. The facts stated that federal law recognized no gain or loss on either step.

The Comptroller concluded:

• LLC 1: no increase or decrease in earned surplus if the grantors' individual federal returns recognized no gain or loss.
• LLC 2: no effect if no gain or loss would be recognized by LLC 2 assuming it filed a separate Form 1065 partnership return.

Currency note: This response addresses only the former earned-surplus component. Texas replaced that tax with the margin tax effective January 1, 2008.

What this means for you

Disregarded LLCs restructuring property holdings

The Texas result followed the federal income computation identified for each type of owner. The ruling did not supply an independent Texas gain calculation.

Tax professionals

The two LLCs required different federal reference points: owner-level individual returns for LLC 1 and a hypothetical separate partnership return for LLC 2.

Common questions

Q: What property was contributed?
A: Commercial real property in Texas.

Q: What did the LLCs receive?
A: A combined 99% limited-partnership interest.

Q: Was the result unconditional?
A: No. It depended on no gain or loss being recognized in the relevant federal computations.

Citations and references

• 34 Tex. Admin. Code Sec. 3.562(f)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9907780L

Original ruling text

July 7, 1999

Dear **:

In your letter of June 16, you requested a determination regarding the
franchise tax treatment of a proposed transaction. Based on the information
you provided, I presume that your inquiry relates only to the computation of
taxable earned surplus.

You indicate that two single member Virginia LLCs (LLC 1 and LLC 2) own
commercial property in Texas. The sole member of LLC 1 is a revocable grantor
trust. The grantors of the trust are treated as the owners of the trust assets
for federal income tax purposes. Therefore, the income and deductions of the
trust are reported on the individual federal income tax returns of the
grantors. The sole member of LLC 2 is a limited partnership. You indicate
that the income and deductions associated with the LLC's interest in the Texas
realty are reported on the partnership's Form 1065. Therefore, I presume that
LLC 2 is disregarded for federal income tax purposes.

The LLCs plan to form a Virginia limited partnership (LP) with a Virginia S
corporation. The LLCs will receive a combined 99% limited partnership interest
in LP in exchange for their ownership interests in the commercial property in
Texas. For federal income tax purposes, no gain or loss is recognized on the
contribution of the real estate to LP.

The LLCs will then liquidate and distribute their interests in LP to their
member. No gain or loss is recognized for federal income tax purposes on
distribution of the partnership interest to the member.

The transactions described would not increase or decrease taxable earned
surplus for LLC 1 if no gain or loss is recognized on the individual federal
income tax returns of the grantors of the trust (Rule 3.562(f)). Similarly,
these transactions would not affect the taxable earned surplus of LLC 2 if no
gain or loss were recognized by LLC 2 if a separate Form 1065 partnership
return were filed for that LLC.

This response is based on the facts presented and current law. If there are
different or additional facts, the response may change.

If you have any questions, contact Tax Policy Division. You may call toll free
1-800-531-5441, or our regular number is 512/463-4600. My extension is 3-4662.
You may write me at Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Bob Jeffcoat
Tax Policy Division