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Brenda Guy
Brenda Guy, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 151
Experience:  20 years of working with income and estate tax issues for families and businesses.
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If I make payments to a bank to settle a personal guarantee

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If I make payments to a bank to settle a personal guarantee of a loan to an LLC which I own a % of, is this a capital loss or a business bad debt write off? I also made loans to these companies which have gone bad due to the recession. They own and lease out commercial real estate. The loans were arms length, but were made in lieu of capital contributions which were not permitted under the LLC operating agreements, unless approved by all members. These loans were at prime plus 2 % and unpaid interest was added to principal.Interest was paid for the first couple years. They were due in November 2007. I sent a demand note recently to the companies and to the guarantors of my notes who are the managing members but of course there's no money. Are these business bad debts or capital losses? The companies are all financed 100% with loans from banks and owners.
Submitted: 3 years ago.
Category: Tax
Expert:  Brenda Guy replied 3 years ago.

Brenda Guy :

It will be a business bad debt once you have made efforts to collect and have determined that you will not be reimbursed.

Customer:

I can't collect from the bank to whom I made a settlement payment under a personal guaranty. The bank doesn't owe me anything except an agreement that the settlement is final and that the guaranty is cancelled. So how can this be a business bad debt?

Brenda Guy :

It is a business bad debt because you had to pay a debt of a business venture that you invested in.

Brenda Guy :

The other members would be the ones that you would try to collect from. It appears from your initial facts that you have.

Customer:

As far as the promissory Notes i have with the LLC's, don't I have to make the case that I am in the "trade or business" of lending money in order to claim a business bad debt? I did mak 4 loans, and prior to that I loaned money to another company and have loaned money in private placements for real estae construction loans. Maybe that means I am in the trade or business of making loans. I'm concerned that the LLC's to whom I leant money were thinly capitalized and that the IRS would claim that my loans were equity not debt. We're talking about 6 and 7 digit loans here!

Brenda Guy :

You don't have to be in the business of making loans. You need to have become obiligated to pay due to a business purpose. The business purpose is the investment in the LLC. You have the operating agreement and the loan documents to prove business purpose. A personal bad debt would be if you loaned money to a friend and they did not pay you back. In that case you did not loan the money with the intent of entering into a business venture.

Brenda Guy, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 151
Experience: 20 years of working with income and estate tax issues for families and businesses.
Brenda Guy and other Tax Specialists are ready to help you
Expert:  Brenda Guy replied 3 years ago.
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Expert:  Brenda Guy replied 3 years ago.
Sorry I had to end the chat. If there are any other follow up questions let me know.
Customer: replied 3 years ago.
This is great news! More facts: 3 of the LLC's are treated as passive by me since I don't qualify as an active investor under the rules. So the write offs will be passive to me. Where do I report these write-offs, on schedule E? On what line and what supporting docs must be attached? One of the LLC's invested in land so its losses were ordinary ( and non passive to me) because it's land held for investment, not real estate rentals. So I'm taking these losses against ordinary income. Here's another quirk: I guaranteed a loan by a bank to one of the LLC owners the purpose of which was to buy two condo units from the LLC for his use as a doctor's office. The proceeds of the loan were used by the LLC which owned the two units to repay a bank loan which was being called. I did this to finance the call. The doctor subsequently defaulted and I had to settle with the bank by paying off part of the loan and facilitating a foreclosure. Is this a business bad debt?
Expert:  Brenda Guy replied 3 years ago.

Passive losses are limited to passive income. They would be reported on 4797.

I am going to answer the doctor office question. However that should be a new question.

I think it is similar to the other facts and I would also treat that a business bad debt.

Customer: replied 3 years ago.

If you need more info about the guaranty of the bank loan to the doctor, who is a partner in the LLC (along with me and two others) which sold the two condo units to him, let me know. I plan to sue him to repay the loan payments I made (as well as taxes) on his behalf after the bank forecloses on the two condo units. He's apparently insolvent, so suing may not make sense except to get my judgement against him on file with the court.

 

Regarding the non-passive investment, where on Schedule E do I report the bad debt write off?

Expert:  Brenda Guy replied 3 years ago.

Bad debt gets written off on form 4797 for non-passive and passive. For passive you also have form 8252.

As far as the doctor that is a new question.

Brenda Guy, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 151
Experience: 20 years of working with income and estate tax issues for families and businesses.
Brenda Guy and other Tax Specialists are ready to help you
Customer: replied 3 years ago.
The CPA I had review my situation is not in agreement with taking my losses on loans to partnerships or my payments against guarantees of partnership debt as business bad debts. He says they're both capital losses. He says that I get the benefit of ordinary losses when the partnership uses my loan to pay its expenses and deducts the expenses from income, thereby reducing taxable income of the partnerhsip. This works if I loan money to the partnership in the same proportion as my ownership interest in the partnership; however my loans in some cases exceeded my interest in the partnerships, so i did not get the benefit of th deductions taken by the partnership. Do you agree with his analysis? Can I ask the partnership to amend its returns of prior years so the loss allocations are similar to my % of the "capital" (loans) made to the partnerships? Do you agree that payment by a partner of the partnership's loans as a result of personal guaranties of the partner are an increase in basis and not business bad debts?
Expert:  Brenda Guy replied 3 years ago.

The character of the loss is a difficult analysis. It is going to be subject to the CPA preparing the return's analysis of the facts. I do not agree that it needs to be in the same proportion as your ownership. You can ask the partnership to amend returns. However, they are only going to do it if it is accordance with the laws.

I do agree that a payment by a partner of the partnership's loans as a result of personal guaranties are an increase in basis. They become bad debt when you can no-longer recover the basis in liquidation of the partnership.

 

Customer: replied 3 years ago.

So it sounds like you're saying that (a) my loans to the partnership to pay its expenses or for capital improvements and (b) payments to the bank of the partnership's loans because I''m a guarantor both are an increase in my basis in the partnership. So when the partnership is liquidated my capital gain is lower or my capital loss is higher; but I don't get a deduction against ordinary income in excess of $3000 because these expenditures are not characterized as business loans and therefore cannot be charged off as business bad debts when uncollectible (loans) or paid (guarantee payments). This appears to be a reversal of your previous position where you said if my loans were made for business purposes, even if I am not in "the trade or business" of making loans, I could get a bad debt write-off if they were uncollectible.

 

FYI, when I made these loans, I purposely loaned the money directly to the partnerships with a signed promissory note, charged market interest, collectedinterest for a period of time, some of the loans were repaid, new advances were made and in two cases, the managing member guaranteed the loans personally. However, no members contributed equity capital so the partnerships were funded entirely with full recourse secured (and guaranteed) bank loans and unsecured (but guaranteed) member loans.

 

The fact that my loans were not made in proportion to my ownership is very important: I did not receive the full benefit of the losses incurred by the partnerships (which were mostly passive and will be usable when the partnerships are wound down). This means that some partners have more negative capital accounts than they would otherwise have had and of course face higher capital gains on disposition. But they also will have more passive losses.

Expert:  Brenda Guy replied 3 years ago.

I believe that sounds correct. This is a very complicated question. If you don't already have a CPA of your own you should probably engage one. Often the CPA of the LLC or partnership is going to answer in the best interest of the LLC. You need someone to do this analysis with your facts.

This will be more costly than Just Answer. But you will have an answer that is based on the law that you can rely on.

Customer: replied 3 years ago.
What does this mean: "They become bad debt when you can no-longer recover the basis in liquidation of the partnership." ? Does this somehow convert capital loss into ordinary loss?

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