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staged or multiyear pay-in. If such a con-
Members sometimes make contributions tribution is made to an LLC classified as
a partnership, the member’s outside basis
to an LLC in installments or pursuant to a generally is increased only as the contri-
subscription note payable to the LLC. bution obligation is retired (i.e., as con-
tributions are made) (Rev. Rul. 80-235;
Oden, T.C. Memo. 1981-184).

transaction, the transferee’s basis is deter- LLC’s inside basis in its assets and the Example 5. Deferred member contri-
mined under the nonrecognition provi- members’ aggregate outside bases in butions (staged pay-ins): M and J form
sions that apply. For example, an LLC their LLC interests are equal. an LLC classified as a partnership
interest can be acquired in a distribution that has no liabilities. M contributes
from a corporation or another partner- Example 4. Determining outside basis $150,000 cash, and J contributes
ship or LLC. The transferee’s basis in when member inherits LLC interest: $40,000 cash and a personal note for
an interest distributed from an LLC Assume the same facts as Example $110,000. The note bears a market
classified as a partnership is determined 3, except E inherits B’s interest in T. interest rate but does not have fixed
under the rules of Sec. 732, which gener- If the alternate valuation date is not payment dates. J intends to retire
ally provides that the interest’s basis is its elected, E’s initial outside basis in the note within 10 years. During
adjusted basis to the LLC immediately the LLC interest is $50,000 — the year 2, J contributes $20,000, reduc-
before the distribution. FMV of the interest on B’s date of ing his contribution obligation by
death. The transfer of the interest to that amount.
Example 2. Determining outside E creates an imbalance between E’s
basis when member purchases interest share of the inside basis of LLC as- M’s initial outside basis is $150,000.
from another member: B owns a 25% sets (25% × $160,000 = $40,000) and J’s initial outside basis is only $40,000 —
interest in T Investors LLC, which is E’s outside basis. If T does not have his cash contribution. J has no additional
classified as a partnership. T has no a Sec. 754 election in effect, E may basis as a result of his note. His basis
liabilities. B sells his interest in T to R want the LLC to make the election to increased by $20,000 when he actually
for $50,000. At that time, B’s outside adjust the basis of its assets in order to made a payment to reduce the note’s
basis in his interest is $40,000, and the reflect the step-up of B’s interest in T principal balance.
LLC’s basis in its assets is $160,000. to FMV on the date of his death. Practice tip: If the LLC wants to
The FMV of T’s assets is $200,000. keep track of a subscription note balance,
R’s initial outside basis in the LLC in- Practice tip: Determining the the note can be booked as an asset with
terest is $50,000 — his purchase price. value of an LLC interest requires some an offsetting entry to a deferred capital
His initial basis is determined without professional judgment. For example, contribution account. This allows for the
reference to the LLC’s basis in its as- a valuation discount may apply if the disclosure of the asset on the books but,
sets. Because the transaction creates interest represents a minority interest or for tax purposes, makes it clear that J’s
an imbalance between R’s share of there are restrictions on its transferability. capital account does not include the de-
the inside basis of LLC assets (25% × If the value of a decedent member’s ferred contributions. Also, the note must
$160,000 = $40,000) and R’s outside estate is less than the applicable exclu- be recorded in the LLC’s book capital
basis ($50,000), the LLC must adjust sion amount, the LLC interest should accounts at FMV to comply with the
the basis of its assets if a Sec. 754 elec- be included in the estate at its highest capital account maintenance provisions
tion is made or is in effect. reasonable value, which maximizes the under the substantial economic effect
heirs’ basis in the interest without any safe harbor. ■
Example 3. Determining outside basis estate tax cost.
when member acquires LLC inter- Contributor
est by gift: Assume the same facts as How subscription notes affect
Example 2, except B decides to gift outside basis Sheila Owen, CPA, is a senior specialist
his interest in T to his daughter, E. Members sometimes make contributions editor with Thomson Reuters Checkpoint.
Her initial outside basis in the LLC to an LLC in installments or pursuant to For more information about this column,
interest is $40,000 — a carryover of a subscription note payable to the LLC. contact thetaxadviser@aicpa.org.
B’s basis. After the transaction, the This arrangement is sometimes called a

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