Dana, Chris, and Mike operate a partnership named Spendalot partners. Spendalot is a general partnership. However, Dana and Chris work hard at the business, and Mike although he is an owner has very little active involvement in the business. Spendalot operates a peach tree orchard in Bay Village, Ohio. The partnership has existed for more than 10 years. It is located on a 100 acre farm, which they had purchased for $1 million, putting down $100,000 down payment, and borrowing $900,000 of recourse debt. The land and property are currently worth $1,500,000. Because of a concern about possible liabilities, they decide they want to convert their general partnership to an LLC. Each of them is a one-third partner. At the present time, Dana has an adjusted interest in the partnership $350,000. Chris has an adjusted basis in her partnership interest of $250,000. And Mike has an adjusted basis in his partnership interest of $400,000. The partnership is a September 30 fiscal year. If they do convert to an LLC, the LLC will elect to be treated as a partnership for federal income tax purposes.

1. What will be the tax consequences to each partners adjusted basis and treatment of the liabilities if the partnership is converted to an LLC?

2. Will the partners need to recognize a gain or a loss on the conversion to an LLC? 3. Does the change from partnership to LLC have an effect on the sharing of the liabilities, which are recourse liabilities?

4. Would your answer change to question number three, if the liabilities had been nonrecourse liabilities?

5. After they convert the partnership to an LLC, do any of the three owners have a good chance to take out part or all of their profit share without incurring self-employment tax? If so, why, and what are the standards that apply?