In general, distributions of property other than cash from an LLC taxed as a partnership are tax-free to the members. This feature of an LLC is one reason why a business operating as an LLC may choose to be taxed as a partnership rather than a corporation.
However, there are five circumstances in which a distribution of property other than cash to a member can trigger gain recognition to a member or LLC. This article examines the concept of ‘hot assets’ which are assets that can trigger one of the five circumstances where member or LLC must recognize gain on a distribution of assets to a member.
Hot assets are a particular type of asset held by an LLC taxed as a partnership. They consist of items other than cash and labeled for accounting purposes as an ‘unrealized receivable’ or as ‘inventory’. Hot assets are assets that have been sold by the LLC for an ordinary loss rather than a capital loss. The partnership tax rules require a member’s gain or loss from the sale of hot assets to equal the gain or loss from the sale of assets that are not hot assets.
The application of IRC Section 751(b) to the distribution of property other than cash can trigger income or loss that the member receiving the distribution has to recognize. Section 751(b) applies if a distribution of property other than cash to a member would cause a member’s share of income and loss from assets that produce capital gain and loss to differ from the member’s share of income and loss from hot assets. Section 751(b) essentially requires a distribution of non-cash property to change the percentage share a member has in capital gain or loss property compared with hot assets resulting in LLC and member gain recognition on the distribution.