Have a Tax Question? Ask a Tax Expert
Hello, Thank you for using justanswer. I can assist you with your questions today.
My question is whether there is any value in the loss that was allocated to me in past years and is still on the books? - Yes this loss is most likely a passive loss since you were not able to use it and it is carried forward for you for tax purposes until you have taxable income. Once you have taxable income the loss can be applied to the taxable income thereby reducing taxable income.
Is there any way to use the loss? For example in the case that the company started making money. - The only way you really get to use the "loss" is by way of reducing your taxable income. There is no other economic benefit to use the "loss".
Please let me know if you have any further questions.
Are you saying that I can apply the loss that was allocated to me to other income? I thought that the usable loss from an enterprise was limited to the basis. If not, would not this create the ability to create loss out of thin air? For example two people could create an LLC where one puts in $100, the loss is allocated to the other, the LLC is closed and the first takes a $100 capital loss on the money he put it so each gets $100 of loss.
Are you saying that I can apply the loss that was allocated to me to other income? - Generally not "other income", since it sounds like a passive loss you can only apply it when you have income from the activity. (Income creates basis)
I thought that the usable loss from an enterprise was limited to the basis. If not, would not this create the ability to create loss out of thin air? - You are correct, in order to utilize a loss you must have basis.
Sorry, I am not understanding. The LLC allocated a lot of loss to me. I used the loss up to my basis so now my basis is 0. Should I carry the rest of the loss forward
I was actively engaged in the business and did not take the loss as a passive loss. Does it carry over as a active loss or a passive loss? Now I am a 100% owner of the entity that produced the loss. Can I reduce my taxable income from other endeavors with this loss? Can I reduce taxable income from this entity with the loss?
OK sorry for the confusion here. Since your activity here is "active" then losses are allowed to the extent that you have basis. Any unused losses, suspended because of a basis limitation, get carried forward indefinitely until you have basis.
It get's carried forward as an active loss.
Yes you can reduce taxable income from other endeavors with this loss provided you have sufficient basis in the activity. Note that if you receive income from the activity that would increase your basis.
Yes you can reduce taxable income from the entity with the loss suspended. (assuming you have sufficient basis)
I hope this makes sense for you. Please let me know if something is not clear.
So it sounds as though I must keep this entity around and keep filing tax returns for it. When it starts generating income I can reduce the income allocated to me until the loss that was allocated to me is used up?
If I have to add capital to the entity then I can use the carried forward loss against other income?
What form should I be carrying the loss forward on?
When it starts generating income I can reduce the income allocated to me until the loss that was allocated to me is used up? - Correct. You don't have to keep it around though. If you decide you want to dispose of it then the unused loss can be deducted as a long term capital loss.
But only to the amount of my basis which is zero, correct?
No, not correct. If you have negative basis and you dispose of the activity then you have a long term capital loss up to the amount of your negative basis.
What form should I be carrying the loss forward on? - I believe you would use form 6198. http://www.irs.gov/pub/irs-pdf/f6198.pdf
This surely sounds like the situation that I described of creating loss from nothing. You form an LLC, get some investors to put in $2 million and spend all the money on research, and allocate $1 million of loss to yourself and $1 million to the investors. You have loss but no basis so cannot use the loss. The investors use the loss because they have basis. When you close the company the investors get to take a capital loss on the rest of their basis. You get to take a capital loss because you were allocated the ordinary loss? So in the end the $2 million of basis created $3 million of loss?
You get to take a capital loss because you were allocated the ordinary loss? - Sorry I did not explain this well. When you dispose of the activity you will get to realize the loss. But since you do not have basis you will experience a long term capital gain which will provide you basis in the activity, thus allowing the loss. Since your basis is negative you will experience a long term capital gain not a loss. (generally I always see it as someone who has basis and disposes of the activity which creates the capital loss) (your fact pattern is the opposite, you have no basis and if disposed, will create a capital gain).
And because I was not able to use the loss against other income, the capital gain is exactly matched against the carried forward loss and the end result is a wash? That is I do not end up paying tax on the gain?
Basically you will end up in a better position. You will get an ordinary loss deduction (at your highest tax rate) and a capital gain (subject to capital gain rates of about 20%)
The end result is wash from an accounting perspective but from a tax perspective you should experience an overall "tax benefit"
Ah. In the year that the company closes, I pay tax on the capital gain, but that gives me basis that I can then write off against other income in that year and future years?
Just in that year. When you dispose 100% of the loss will be released.
So ideally I would pick a year that I have a large capital loss and a lot of ordinary income?
Did you also say that producing income in the entity creates basis? So the answer to the original question is that there two ways to get some value from the situation? (1) dispose of the entity, pay capital gains, and take ordinary loss or (2) make the entity profitable and write the income off against the carried forward loss.
Add to (2) that when the entity eventually closes there would still be a long term capital gain on the negative basis.
So ideally I would pick a year that I have a large capital loss and a lot of ordinary income? - Yes that would be beneficial from a tax planning perspective.
Did you also say that producing income in the entity creates basis? - Yes correct, if you get an allocation of book income that would provide you with basis up to the amount of income allocated. So the answer to the original question is that there two ways to get some value from the situation? (1) dispose of the entity, pay capital gains, and take ordinary loss or (2) make the entity profitable and write the income off against the carried forward loss. - correct, these would be two methods to derive value from the LLC.
Add to (2) that when the entity eventually closes there would still be a long term capital gain on the negative basis. - yes exactly.