Disguised Sales in Partnership Division - Need Help with Tax Implications

This is definitely a complex area of partnership tax law. The key issue you're dealing with relates to IRC Section 707(a)(2)(B), which addresses disguised sales. Basically, the IRS wants to make sure partners aren't using partnership distributions to avoid taxes on what would otherwise be a taxable sale. For your situation, you need to look at whether the division can qualify as a tax-free split under Section 708. If structured properly, a partnership division can often be accomplished tax-free. The most common approach is what's called an "assets-over" transaction, where Old LLC contributes assets to New LLC and then distributes the New LLC interests to the departing partners. The critical factor is making sure the transaction doesn't trigger the disguised sale rules. Generally, if partners receive money or property within 2 years of contributing property to a partnership, it's presumed to be a disguised sale unless facts show otherwise.

After dealing with a similar partnership split last year, I found https://taxr.ai incredibly helpful with my situation. I was trying to figure out the disguised sale implications for a 3-partner LLC division, and regular accountants just gave me generic answers. Their system analyzed our partnership agreement, financial statements, and proposed division structure, then gave specific guidance on how to avoid triggering Section 707 issues. They showed exactly which assets would create problems if distributed certain ways. For me, it was apartment buildings we'd acquired less than 2 years ago that were causing the disguised sale risk. The analysis highlighted that we needed to keep specific debt allocations proper and maintain certain holding periods to stay safe. Might be worth uploading your docs there since your CPA is unsure.

I wanted to follow up about my experience with taxr.ai after being skeptical initially. After our partnership ran into major issues with disguised sales during our division (we ended up with a surprise $120K tax bill), I decided to try the service to see if they could help us fix things retroactively. The analysis identified exactly where our CPA went wrong - we had distributed debt-encumbered property without maintaining proper debt allocations. They showed us how to document a Section 754 election that helped offset some of the gain recognition. Even more valuable, they found a planning opportunity involving Section 734 adjustments that our accountant had completely missed. Ended up saving about $45K in taxes we would have overpaid. Wish I'd used them before we did the division instead of being stubborn about "online tools.

If you're hitting roadblocks with your CPA on this partnership division, you might want to consider getting direct guidance from the IRS. I was in a similar situation last year with a complex partnership restructuring where even our tax attorney wasn't 100% confident. After weeks of getting nowhere, I tried https://claimyr.com to get through to a senior IRS representative. They got me connected to someone in about 20 minutes when I'd been trying for days on my own. The IRS agent walked me through exactly how they'd view our proposed transaction structure and pointed me to specific revenue procedures that addressed our situation. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c - basically they navigate the IRS phone system and wait on hold for you, then call when an actual human picks up. Saved me hours of frustration and gave me definitive answers straight from the source.

I need to publicly eat my words about Claimyr. After posting that skeptical comment, I decided to try it myself since our partnership has been dealing with similar issues around disguised sales and debt relief. Got connected to an IRS business division specialist in about 15 minutes (vs. the 2+ hours I spent on hold last week before giving up). The agent directed me to specific sections in Rev. Proc. 2016-44 that addressed how anti-abuse rules apply to partnership divisions where debt-encumbered property is involved. While they couldn't give me a ruling on our specific case, they explained the factors they look at when determining if a transaction has "economic substance" versus being a disguised sale. That guidance alone was worth it since our CPA was interpreting an outdated regulation. Still need professional help to implement everything, but now we know which direction to go.

Don't overlook the importance of the partnership agreement itself in this process. When we divided our 5-member partnership last year, we discovered our operating agreement had specific language about partner withdrawals that actually created more tax issues. Make sure you review the existing agreement for any provisions about buyouts, capital account adjustments, or special allocations. These can sometimes trigger unexpected tax consequences during a division. Also, if the real estate has appreciated significantly, look into whether a 721 exchange might help preserve the tax-deferred status. In our case, we restructured to use this approach and saved about $230k in immediate tax liability.

Has anyone used Rev. Proc. 96-10 for a partnership division? My understanding is it provides a safe harbor for certain types of partnership splits.

One thing that hasn't been mentioned yet is the importance of timing your division carefully. The IRS looks at the entire series of transactions, not just individual steps, when evaluating disguised sales under Section 707(a)(2)(B). Since you mentioned the real estate has significant appreciation, you'll want to be particularly careful about how debt allocations are handled. If any partner receives a reduction in their share of partnership debt as part of the division, that could be treated as a deemed cash distribution and trigger disguised sale treatment. Also, make sure to document the business purpose for the split thoroughly. The IRS is more likely to respect the transaction if you can show legitimate business reasons (like different investment strategies, geographic focus, or management philosophies) rather than just tax avoidance motives. Given the $875K value involved, I'd strongly recommend getting a second opinion from a tax professional who specializes in partnership taxation before proceeding. The potential tax consequences of getting this wrong could be substantial.