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. ‘Disguised sales’ are transactions in which a member of an LLC transfers property to an LLC and receives cash or other property in return. A disguised sale transaction can trigger one of the five circumstances where a member or LLC must recognize gain on a distribution of assets to a member.
Under IRC Section 707(a)(2)(b) if an LLC member contributes property to an LLC and the LLC distributes cash or other non-cash property to the member within two years of the member’s contribution, then the transaction is presumed to be a sale of property by the member to the LLC rather than a tax-free contribution of property to the LLC and a tax-free distribution of cash or other property to the member.
Section 707(a)(2)(b) also applies if an LLC member contributes cash to an LLC and receives property from the LLC within two years of the cash contribution.