By: Tamara B. Pow
Are you calculating the LLC fee correctly for an LLC’s sale of real estate?
The Franchise Tax Board just released FTB Legal Ruling 2016-01 (July 14, 2016) regarding the calculation of the limited liability company fee under California Revenue and Taxation Code Section 17942 for real property held for sale to customers in the ordinary course of business, as well as real property held for investment purposes. The FTB analyzed two fact situations. In the first scenario, a California LLC classified as a partnership holds real property for sale to customers in the ordinary course of its business and sells it during the 2016 taxable year. In the second scenario, the same LLC instead sells a parcel of unimproved real property held for investment purposes during the 2016 taxable year. The FTB ruled that the term “cost of goods sold” for purposes of RTC 17942(b)(1)(A) includes real property held for sale to customers in the ordinary course of a trade or business. “Therefore, LLCs that are dealers in real property must add the cost of goods sold (based on real property) back to gross income in calculating the LLC fee.” In the first scenario, the LLC’s adjusted basis in the real property will be added back to gross income for calculating the LLC fee due. In the second scenario, where the LLC sold investment property instead of inventory property, the adjusted basis in the property will not be added back to gross income for calculating the LLC fee.
The FTB’s analysis focuses on legislative history regarding the use of the term “cost of goods sold” as it may relate to real estate. The ruling states that the Legislature’s intent was that the LLC fee be based on gross receipts for all LLCs, including LLCs that are dealers in real property. Similarly, Congress has also used the term “cost of goods sold” in relation to construction of real property by a taxpayer in the ordinary course of business, in the American Jobs Creation Act of 2004. The Tax Court has also used “costs of goods sold” to refer to the cost of the property sold, regardless of whether or not it was inventory. The US Supreme Court has also used the term “gross profit,” which is associated with cost of goods sold, in a case dealing with a real property dealer’s sale of real property. The FTB concludes that if “costs of goods sold” in RTC 17942 could not include real property, then Congress, the IRS and the courts would have been incorrect in their usage. As a result, “LLCs that are dealers in real property must add the costs of goods sold (based on real property) back to gross income in calculating the LLC fee.”
Tamara B. Pow is a founding partner of Strategy Law, LLP in downtown San Jose, California where she practices business and real estate law including limited liability company formations and operations, and both inventory and investment real property sales. Her consistent and extensive work with LLCs keeps her up to date when advising owners of LLCs and other business entities of Secretary of State updates and other changes in structuring real estate transactions and the legal requirements of maintaining business entity liability protection.
The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.