I have a small construction business with three pieces of equipment. The business is a CA LLC with me and my wife 50/50 members. I created a holding company to transfer the three pieces of equipment for liability purposes. This is also a LLC with me as the sole member. What is the best way to transfer the assets? Would a fair market value sale result in sales tax or tax on the gain of sale? Or can I simply transfer the assets with the accumulated tax depreciation? Thank You.
2 Answers from Attorneys
The answer to your questions depends ona n umber of facts you have not described. It will be important to see the tax returns filed on these entities and the business operation. Has depreciation been taken? What is the adjusted basis of the equipment? Since it is tangible personal property a sales tax is likely if you sell equipment, but may not apply if you sell LLC interests or Corporation stock. No matter what thwe tax, you are economically better off to sell at market value and pay the tax than to sell for less. This may change if you have debt related to the acquisition of the equipment. A capable tax advisor should advise you on these questions.
One general rule to follow in any transaction between a small-business owner and his or her business, or between two businesses controlled by the same person or small group, is that the terms of the transaction should make economic sense. Whenever I see a new corporation giving its owner piles of stock without any payment being made, or equipment being sold to the business for well below (or well above) its true market value, I wonder who's fooling whom, and what will happen when the auditors arrive. So, Rule #1 is that the deal terms need to make economic sense. It should be a deal (or at a price) that two strangers could have made.
The second rule is to document your transaction. Don't try to whip up a bill of sale after there's been a fatality involving a machine, or the repo man arrives. In addition to the documents authorizing and carrying out the transfer of ownership, you'll need some kind of a lease-back or use agreement. The terms should also approximate what would happen in an arms' length transaction, and should contain an insurance clause.
Next, as far as California sales or use taxes go, your proposed capital transaction is probably exempt. I say probably because although I've just verified that there is an exemption for transactions where a new business is being capitalized, I haven't read (or even looked for) any fine print that might qualify the generalization.
As far as capital gains taxes (state and federal) go, you'll probably avoid any taxable gain or loss if the transfer takes place at the tax-adjusted basis of the property.....the transfer should be for the value (in cash or equity) of the equipment as recorded in the transferring company's tax books. Ask your tax accountant if you don't know it. Of course, there could be perfectly good reasons for selecting a different (sensible) valuation.....maybe your business has offsetting capital gains or losses, for example.
Finally, ask yourself if it's worth it. Liability issues can perhaps be more effectively addressed with insurance. Sometimes, transferring property to a related entity can be un-done in court, e.g. see the Uniform Fraudulent Transfer Act at Civil Code sections 3439 to 3439.12. Maintaining a separate LLC just to own three pieces of equipment seems to be a lot of work and expense. If the LLC's annual gross revenues exceed $250,000, it will be subject to a fairly significant tax on those revenues, see Revenue & Taxation Code section 17942.