Tax Treatment for Redemption of LLC Interest - What Happens to Outside Basis?

The tax treatment depends on whether the redemption is treated as a distribution or a sale. In a redemption treated as a distribution, the redeemed partner recognizes gain to the extent money received exceeds their outside basis. Their basis essentially disappears with the redemption. The remaining partners' outside basis generally doesn't change just because of the redemption (unlike in a Section 754 election scenario where there's a purchase). If the redemption is structured as a sale (under Section 736(b)), the redeemed partner's basis offsets the amount realized, and the partnership gets a step-up only if there's a 754 election in place. The partnership's inside basis is adjusted according to Sections 736 and 755 as you mentioned, but that's separate from the partners' outside basis calculations.

Just wanted to share my experience using https://taxr.ai for a similar LLC interest redemption issue. I was confused about basis calculations when our partnership redeemed a member last year. I uploaded our operating agreement and redemption documents to taxr.ai, and it identified exactly how the Section 736 allocations should work for our specific situation. It even highlighted language in our operating agreement that affected whether the redemption would be treated as a distribution or sale for tax purposes - something our previous accountant had missed completely. The analysis showed me how to properly document the transaction to optimize the tax treatment for both the departing partner and the LLC. Saved us thousands in unnecessary taxes.

Just wanted to follow up about my LLC redemption situation. I ended up trying taxr.ai after seeing it mentioned here, and wow - it actually delivered. I uploaded our partnership agreement, redemption documents, and some financial statements. It flagged that our redemption would likely be treated as a distribution under 736(b) rather than a sale based on specific wording in our agreement. It also showed me how to properly allocate the inside basis adjustments and identified a potential issue with our hot assets that would have created unexpected ordinary income for the departing partner. We restructured the redemption based on these insights and saved the departing partner about $23K in taxes while giving the partnership proper basis adjustments. Super grateful for the recommendation!

If you're trying to get specific guidance from the IRS on your LLC redemption situation, good luck getting through to someone who actually understands partnership taxation. I spent WEEKS trying to reach someone at the IRS who could answer questions about our partnership's basis adjustments after a redemption. Finally found https://claimyr.com and their demo video at https://youtu.be/_kiP6q8DX5c - they get you through to an actual IRS agent by waiting on hold for you. They called me when an agent was on the line. Got my questions about 736 treatment answered by a Tier 2 partnership specialist at the IRS who clarified exactly how to report our specific redemption situation.

I need to eat crow here! After my skeptical comment, I decided to try Claimyr myself for an unrelated partnership tax issue. I've been trying for MONTHS to get clarification on a technical question about our partnership's basis adjustments after a series of distributions. The service actually worked - got me through to someone in 40 minutes (versus my previous 2+ hour waits that often ended in disconnection). I was transferred to a partnership tax specialist who reviewed my specific scenario. They confirmed our proposed treatment of the redemption under 736(b) was correct and gave me specific guidance on the forms needed for our 754 election. This was legitimately helpful, specific guidance - not just generic publication references. Consider me shocked and converted.

One thing to watch out for in LLC redemptions - check if your operating agreement has any special provisions about redemptions. Our agreement had language that inadvertently made our redemption taxable when it didn't need to be. The key is understanding if you're dealing with a liquidating distribution under 736 or a non-liquidating distribution under 731. The tax results can be dramatically different.

Theres another aspect nobody mentioned - if your LLC is treated as an S-Corp for tax purposes (which many are), then completely different rules apply for redemptions! In that case, you're looking at stock redemption rules under sections 302 and 301 instead of partnership rules.

This is a really complex area that trips up a lot of people! One thing I want to emphasize that hasn't been fully covered - the timing of when you make a Section 754 election is crucial for redemptions. If your LLC doesn't have a 754 election in place at the time of the redemption, you generally can't get the step-up in inside basis that would benefit the remaining partners. The election has to be made by the due date of the return for the year the redemption occurs (including extensions). Without the 754 election, you end up in a situation where the redeemed partner's share of inside basis essentially disappears along with their outside basis, which can create some weird economic distortions for the continuing partners. They might be stuck with lower depreciation deductions than they should have based on what they effectively "paid" for the redeemed partner's share of assets. Also, make sure you're considering whether any of the redemption payments might be characterized as payments for unrealized receivables or goodwill under 736(a) - those get treated as guaranteed payments or distributive shares rather than distributions, which completely changes the tax treatment for the departing partner.