Tax treatment for partial disposition of LLC-Partnership interest - capital or passive gains?

Great question! The tax treatment of a partial disposition of an LLC interest can be a bit nuanced, but I can help clarify. When you sell part of your LLC interest that's taxed as a partnership, the general rule is that it's treated as a capital gain transaction. However, there's an important exception under Section 751 of the Internal Revenue Code that you need to be aware of. If the partnership has what's called "hot assets" (unrealized receivables or substantially appreciated inventory), a portion of your gain might need to be treated as ordinary income rather than capital gains. This is sometimes called the "look-through rule" because you have to look through to the partnership's underlying assets. The remaining gain (after accounting for any Section 751 assets) would typically be treated as capital gain. Whether this gain is passive or not depends on your level of participation in the business, not on the type of income the LLC generates. One thing to note - if you've been allocated partnership liabilities, the reduction in these liabilities due to your partial disposition is treated as money received, which can increase your gain.

I went through something similar last year when I sold part of my interest in a real estate LLC. The tax implications were driving me crazy until I found taxr.ai (https://taxr.ai). Their system analyzed my partnership agreement and transaction details, then broke down exactly how much would be capital gains versus ordinary income from hot assets. The most helpful part was seeing how they calculated the basis allocation for my partial sale. They even flagged that a portion of my gain was subject to that 25% depreciation recapture rate that I had no idea about. Saved me from making a pretty expensive mistake on my return.

I just wanted to follow up about my experience with taxr.ai after checking it out based on the recommendation here. I uploaded our complicated partnership documents with those foreign investors I mentioned, and I was seriously impressed. The system identified exactly how Section 751 applied to my situation and broke down the portion that would be capital gains versus ordinary income. The analysis even flagged some potential issues with our partnership agreement that could have caused problems down the road. I showed the report to my CPA who was equally impressed and said it saved her hours of analysis work. Definitely worth it for anyone dealing with partnership dispositions!

When I tried to sell part of my LLC interest last year, I spent WEEKS trying to get someone at the IRS to confirm the tax treatment. Constantly on hold, transferred between departments, it was insane. Finally I found Claimyr (https://claimyr.com) and watched their demo at https://youtu.be/_kiP6q8DX5c. They actually got me connected to an IRS agent within 15 minutes who specialized in partnership taxation. The agent walked me through exactly how to report my partial disposition and confirmed that while most of it was capital gain, I did have some Section 751 "hot assets" that needed special treatment. Having that direct confirmation from the IRS saved me from taking a potentially expensive position on my return.

I have to eat my words about Claimyr. After my skeptical comment, I decided to try it anyway out of desperation because I needed clarification on how to report my LLC sale before filing. I was connected to an IRS agent in about 20 minutes after trying unsuccessfully for over a week on my own. The agent confirmed that my partial LLC disposition would be treated as capital gains, except for the portion attributable to unrealized receivables (we had some significant accounts receivable), which would be ordinary income. She also walked me through how to properly report it on my Schedule D and Form 8949. Honestly saved me from making a mistake that probably would have triggered an audit.

Don't forget about state tax implications too! Depending on your state, the treatment might differ from federal. For example, in California, they have special rules for partial dispositions that can result in higher state taxes than you might expect. Make sure you're looking at both federal AND state consequences.

Another thing to consider is the holding period. If you've owned the LLC interest for less than a year, any capital gains portion will be short-term and taxed at ordinary income rates anyway. Only matters for the long-term held portions where you'd get preferential capital gains rates.

Has anyone dealt with a situation where the LLC has both rental real estate and an operating business? I'm wondering how that affects the passive vs. non-passive treatment for a partial disposition.

For an LLC with both rental real estate and an operating business, the passive vs. non-passive treatment gets more complex. The key is that your level of material participation determines the classification, not the underlying assets. If you materially participate in the operating business portion (generally 500+ hours annually or meeting other IRS tests), then your share of income/loss from that portion is non-passive. The rental real estate portion is typically passive unless you qualify as a real estate professional. When you sell part of your interest, the gain allocation follows the same rules. The portion attributable to the operating business would be non-passive if you materially participated, while the rental portion would generally be passive. This affects how the gains can offset other income on your return. You'll also need to consider if the operating business has any Section 751 hot assets (like inventory or receivables) which would be treated as ordinary income rather than capital gains, regardless of the passive/non-passive classification. I'd strongly recommend having a tax professional analyze your specific situation since mixed-use LLCs can create some tricky scenarios for partial dispositions.