To buy out a partner in an LLC, start with the operating agreement, agree on a price using a defined valuation method, decide whether the remaining members or the LLC itself will purchase the interest, put the terms in a written buyout agreement, and then handle the tax filings and state paperwork that make the change official. Each of those steps has real money attached, and the choices you make about structure and payment will follow you into future tax returns for years.
Start With the Operating Agreement
Pull the operating agreement before you talk numbers. Look for sections labeled “Buy-Sell Provisions,” “Transfer of Interests,” or “Withdrawal.” Those clauses typically identify the events that trigger a buyout, the valuation method, and who has the right to buy the departing member’s stake.
Most well-drafted agreements include a right of first refusal: the departing member must offer their interest to the remaining members before selling to an outsider. The agreement may also list specific trigger events like death, disability, retirement, voluntary withdrawal, or bankruptcy. These provisions exist to keep ownership predictable and prevent strangers from suddenly holding a stake in the business.
If the LLC has no operating agreement, or the agreement is silent on buyouts, you’re operating under the default LLC statute of the state where the company was formed. In some states, the default rule can force the LLC to dissolve when a member leaves. That outcome is avoidable, but it means every term has to be negotiated from scratch.
Agreeing on a Price
Price is where most buyouts stall. If the operating agreement specifies a formula, use it. If not, the three standard valuation approaches each suit different kinds of businesses.
An asset-based approach adds up the fair market value of what the LLC owns, subtracts liabilities, and multiplies by the departing member’s ownership percentage. It fits companies with significant tangible property. It tends to undervalue service businesses, consulting firms, or tech companies where the real worth sits in client relationships, recurring revenue, or intellectual property.
A market-based approach compares the LLC to similar businesses that recently sold. That’s a useful sanity check, but genuinely comparable transactions for a small, privately held LLC are hard to find.
An income-based approach values the business on its ability to generate future profits. The most common version is a discounted cash flow analysis, which projects future earnings and discounts them back to present value. It works best for established, profitable companies with predictable revenue. The earnings multiplier is a simpler variant that applies an industry-standard multiple to annual earnings.
When members can’t agree on a number, hire a neutral third-party appraiser. Professional valuations for small LLCs typically run between $2,000 and $10,000, with more complex businesses pushing into the $25,000 to $50,000 range. That’s cheaper than a lawsuit over a disputed valuation.
Discounts for Minority Interests
If the departing member holds less than 50%, the price may be reduced by valuation discounts. A lack-of-control discount reflects that a minority owner can’t unilaterally make business decisions. A lack-of-marketability discount accounts for how hard it is to sell an interest in a private LLC compared to publicly traded stock.
These discounts can be substantial. Lack-of-control discounts commonly range from 10% to 40%, and lack-of-marketability discounts typically fall between 5% and 35%. When both apply, they compound. A 20% control discount and a 30% marketability discount on a $500,000 pro-rata share would reduce the buyout price to $280,000. Whether these discounts are appropriate depends on the operating agreement, the specific circumstances, and in some cases whether the buyout is voluntary or forced.
Cross-Purchase or Redemption
Once the price is set, decide who is actually writing the check. In a cross-purchase, the remaining members personally buy the departing member’s interest. In a redemption, the LLC itself buys back the interest using company funds. The choice has tax consequences that ripple forward for years.
In a cross-purchase, the buying members get a tax basis in their newly acquired interest equal to what they paid. That higher basis reduces their taxable gain if they eventually sell the business. In a redemption, the remaining members don’t write personal checks, but their basis in their own interests doesn’t increase, which means a bigger tax bill down the road when they sell. For LLCs with more than a few members, cross-purchase also gets logistically complicated, since each remaining member has to buy a proportional piece.
Funding the Buyout
Few buyouts happen as a single lump-sum payment. The purchasing side usually combines funding sources.
Seller financing is the most common arrangement. The departing member accepts payment over time through a promissory note, which spares the buyer from producing all the cash at once. The note must charge interest at or above the IRS’s Applicable Federal Rate, published monthly. If the stated rate falls below the AFR, the IRS will impute interest and tax the lender on income they never actually received.
An SBA 7(a) loan can be used for partial or complete changes of ownership, with a maximum loan amount of $5 million. The business must be operating, for-profit, located in the U.S., and small enough to meet SBA size standards. You also need to show that comparable financing wasn’t available on reasonable terms from other sources.1U.S. Small Business Administration. Terms, Conditions, and Eligibility
Life insurance funds many buy-sell agreements. In a cross-purchase, each member owns a policy on the others. In a redemption, the LLC owns the policies. When a member dies, the proceeds fund the buyout without draining operating cash.
Cash reserves or bank financing round out the options. If the LLC has enough retained earnings, it can fund a redemption directly. Traditional bank loans or lines of credit work too, though lenders will want to see that the business can service the debt alongside normal operations.
The Tax Bill on Both Sides
The IRS treats a multi-member LLC as a partnership for tax purposes unless the LLC has elected corporate treatment. That means a buyout follows partnership tax rules, and those rules are more complicated than most members expect.
For the Departing Member
The selling member’s gain or loss is generally treated as a capital gain or loss, the same as selling stock or other investment property.2Office of the Law Revision Counsel. 26 U.S. Code 741 – Recognition and Character of Gain or Loss on Sale or Exchange The gain equals the amount received minus the member’s adjusted basis in their LLC interest. If they held the interest for more than a year, the gain qualifies for long-term capital gains rates.
There’s an important exception. If the LLC holds what the IRS calls “hot assets,” which include unrealized receivables and inventory, the portion of the sale price attributable to those assets is taxed as ordinary income rather than capital gain.3IRS. Sale of a Partnership Interest A professional services firm with substantial accounts receivable, for example, could have a significant chunk of the buyout proceeds taxed at ordinary rates. The ordinary income portion is calculated first and subtracted from the total gain; whatever remains is treated as capital gain.
For the Purchasing Member
The purchasing member should consider asking the LLC to make a Section 754 election. Without it, the buyer’s share of the LLC’s inside basis in its assets stays the same as it was before the buyout, even though the buyer may have paid a premium above that basis. A Section 754 election allows the LLC to adjust the basis of its assets to reflect the actual purchase price, which produces larger depreciation deductions and smaller gains when the LLC sells assets later.4Office of the Law Revision Counsel. 26 U.S. Code 754 – Manner of Electing Optional Adjustment to Basis of Partnership Property The election is made by the partnership, not the individual member, and once filed it applies to all future transfers unless revoked.5Internal Revenue Service. FAQs for Internal Revenue Code (IRC) Sec. 754 Election and Revocation
Filings the LLC Owes
When the LLC holds hot assets and a member sells their interest, the LLC must file Form 8308 to report the transaction to the IRS.6Internal Revenue Service. About Form 8308, Report of a Sale or Exchange of Certain Partnership Interests The departing member also receives a final Schedule K-1 reporting their share of the LLC’s income, deductions, and credits through the date of sale. Work with a tax professional before closing, not after. Structuring payment terms, allocating the purchase price among asset classes, and timing the transaction across tax years can save or cost tens of thousands of dollars.
The Written Buyout Agreement
Once price, structure, and payment terms are settled, everything goes into a formal buyout agreement, sometimes called a purchase agreement. Cutting corners here is where deals unravel months later.
At minimum, the agreement identifies the parties and the exact ownership percentage being transferred; states the purchase price, whether payment is a lump sum or installments, the schedule, and any interest rate on a promissory note; contains representations and warranties about the accuracy of financial records and the absence of undisclosed liabilities; includes indemnification protecting the departing member from liability for things that happen after they leave and protecting the remaining members from undisclosed problems that predate the buyout; and sets a closing date with any conditions that have to be met first, like securing financing or third-party consents. If the departing member personally guaranteed any LLC debts, the agreement should address how and when those guarantees will be released.
Most buyout agreements also include restrictions on what the departing member can do afterward. A non-compete clause prevents them from starting or joining a competing business for a defined period, typically one to two years, within a specific geographic area. A non-solicitation clause bars them from poaching employees or clients. These clauses need to be reasonable in scope, duration, and geography to be enforceable. Courts routinely strike down restrictions that are too broad.
Alongside the buyout agreement, amend the LLC’s operating agreement to remove the departing member and recalculate ownership percentages for the remaining members. If the buyout changes management or voting provisions, the amendment should reflect that too.
After the Closing
Signing is not the finish line. Several administrative tasks need to happen promptly.
Most states require an amendment or statement of change filed with the secretary of state’s office to update the LLC’s public records. Filing fees generally range from $25 to $150 depending on the state. If the LLC operates in states other than its home state, update foreign qualification filings there as well.
Internally, update the signature authority on bank accounts, remove the departing member from company credit cards or lines of credit, and transfer or cancel any powers of attorney. Notify major clients, vendors, lenders, and insurance carriers. Lenders may have consent requirements or acceleration clauses triggered by a change in membership, so check loan agreements before closing rather than after.
If the LLC holds professional licenses, business permits, or industry-specific registrations, check whether those need to be updated or reissued. Ownership changes sometimes trigger a re-application process.
If You End Up as the Only Member
Buying out the only other member in a two-person LLC triggers a fundamental change in tax classification. A multi-member LLC is taxed as a partnership by default. A single-member LLC is treated as a disregarded entity, meaning the IRS ignores it for income tax purposes and you report business income and expenses on your personal return (Schedule C) instead of filing a partnership return (Form 1065).7Internal Revenue Service. Single Member Limited Liability Companies
This classification change happens automatically. You don’t need to file Form 8832 unless you want to elect corporate treatment. The transition still creates administrative work: the LLC’s final Form 1065 must be filed for the short tax year ending on the buyout date, and a final K-1 goes to the departing member. Going forward, the single-member LLC uses its own name and EIN for employment tax purposes even though it’s disregarded for income tax.7Internal Revenue Service. Single Member Limited Liability Companies Check with the IRS on whether a new EIN is required, as the rules depend on the specifics of the transition.
When You Can’t Agree
Not every buyout negotiation goes smoothly. When members are deadlocked on price, terms, or whether a buyout should happen at all, the path forward depends heavily on the operating agreement.
Well-drafted agreements include dispute resolution clauses requiring mediation or binding arbitration before anyone goes to court. Mediation brings in a neutral third party to help find a compromise; the process itself pushes both sides to negotiate seriously. Arbitration is more like a private trial, where an arbitrator hears evidence and issues a binding decision. Both are faster and cheaper than litigation.
Without a dispute resolution clause, the most common legal remedy is a petition for judicial dissolution, where a court orders the LLC to wind down and distribute its assets. Courts generally grant dissolution when members are so deadlocked the business can’t function, when those in control are acting illegally or wasting company assets, or when it’s no longer practical to carry on business under the operating agreement. Judicial dissolution usually destroys more value than a negotiated buyout would, which is why it tends to bring reluctant members back to the table.
The lesson is straightforward: address buyout mechanics in the operating agreement before you need them. Resolving them through litigation costs everyone more and leaves nobody satisfied.