Legal Ruling Changes How Real Estate Dealers Calculate the Limited Liability Company Fee

The State of California Franchise Tax Board (FTB) on July 14, 2016, issued Legal Ruling 2016-01, which changes how real estate dealers are required to calculate the limited liability company (LLC) fee.

The legal ruling requires dealers in real estate to add back to gross income the adjusted basis of property held for sale to customers in the ordinary course of their business. However, if a LLC is holding a property for investment purposes and then sells it, the property’s adjusted basis is excluded from gross income for the purposes of calculating the LLC fee.

Example

Kelly Properties, a multiple member LLC, owns two pieces of real property: Pink Roses and White Gardenia. The LLC purchased the Pink Roses property to sell to its customers in the ordinary course of its business. However, the White Gardenia property was purchased as an investment. The LLC sold both pieces of property in 2016.

For the purposes of computing the 2016 LLC fee, there are two courses of action that Kelly Properties must take:

  • Pink Roses. The adjusted basis must be added back to gross income because the property was sold during the ordinary course of business.
  • White Gardenia. The adjusted basis isn’t required to be added to gross income to compute the LLC fee because this was an investment property.

When Does this Change Take Effect?

In the August issue of Tax News, the FTB stated that it will update 2016 and subsequent forms to include the legal ruling’s conclusions. It doesn’t have plans to commit audit resources to identify prior year tax returns that didn’t conform to this legal ruling’s conclusions.

Potential Penalty

The FTB recognize that LLCs’ reliance on existing instructions regarding the calculation of the LLC fee may subject some LLCs to a potential penalty for underpayment of estimated fee payment, which is under Revenue and Taxation Code (RTC) section 17942(d).

We’re Here to Help

While the penalty doesn’t contain an abatement provision, contact your Moss Adams professional if your LLC is assessed a penalty. We can also help you understand other ways this legal ruling may affect your business.