How Do You Treat Interest on An LLC Sale?

When a member of an LLC decides it's time to move on to another opportunity, they may want to sell their interest in the LLC. Selling LLC interest is like selling other capital assets. If the asset is sold above its cost basis, it will generate a profit. The same is true for LLC interest.

Members of an LLC are similar to corporation shareholders. While a corporation has shareholders, who are owners of the corporation, an LLC has members, who are owners of the LLC. Let’s see what happens when one of these members decides to sell the LLC interest.

Different Ways of Removing LLC Interest

There are three primary methods for removing interest in an LLC:

• Transfer to an existing LLC member
• Liquidation/redemption of interest
• Sale of interest

The LLC operating agreement may have restrictions on the above methods. Members should review any agreement restrictions with their legal counsel before selling their interest.

Tax Implications

There will likely be tax implications on the sale of LLC interest. These implications also depend on the transaction being structured as a sale or redemption. Each can have different tax burdens. Existing members of the LLC can also be impacted by these transactions if their cost basis changes.

Interest transferred as property vs. cash will have different tax implications as well. 

Selling LLC Interest

Selling interest in a partnership LLC falls under IRS Section 751. Gain on the sale of LLC interest is taxed, but how it is taxed depends on the holding period (short vs. long-term) and how the sale is structured. The sale can be structured as an asset sale or equity sale. Each has different tax implications.

Note that a partnership LLC is not taxed. Instead, the individual owners of the LLC are the ones who are taxed.

In addition to any federal taxes, state and sales taxes may be applicable. An equity sale may not have any sales tax, while an asset sale probably will. The sale of tangible property can have varying tax impacts depending on the state.

The member is taxed on gains above their cost basis in the LLC. The cost basis is equal to the member's contribution for LLC interest minus LLC liabilities plus LLC income. It's not uncommon for the basis to change over time.

If the departing member sells 100 units of interest in the LLC to more than one existing member, all parties will need to decide how the units will be split. Selling interest to a trust or another person is a similar transaction.

An attorney can create the necessary documentation for the sale of LLC interest.

Some LLCs may be classified as corporations for tax purposes or disregarded. These can be more complex scenarios when selling interest in the LLC.