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socrateaser
socrateaser, Lawyer
Category: Tax
Satisfied Customers: 37951
Experience:  Retired (mostly)
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I have a client that owned an LLC (1% owned by the wife, 99%

Customer Question

I have a client that owned an LLC (1% owned by the wife, 99% owned by the husband) that owned a building with a mortgage. The mortgage amount exceeded the tax basis, the fmv exceeded the mortgage. He is personally involved in business litigation that didn't involve this LLC, but the judge awarded the LLC to the plaintiff. What does the taxpayer deduct on his taxes? The FMV of the property lost, or just the tax basis of the property. Will there be COD income on the mortgage amount over basis?
Submitted: 9 months ago.
Category: Tax
Expert:  socrateaser replied 9 months ago.

Hello,

Is the client personally obligated for the mortgage (i.e., the borrower, not just a personal guarantor)?

Customer: replied 9 months ago.
Do you mean the llc? Or do you mean the member?
Customer: replied 9 months ago.
I think the llc is liable
Customer: replied 9 months ago.
I don't know if the member signed a pg
Customer: replied 9 months ago.
This would have been a commercial loan
Customer: replied 9 months ago.
For a commercial building
Customer: replied 9 months ago.
The plaintiff never paid the mortgage and the building was foreclosed
Customer: replied 9 months ago.
The member was not sued by the bank
Customer: replied 9 months ago.
I believe calif has a single action rule
Customer: replied 9 months ago.
You can sue or you can foreclose but not both
Customer: replied 9 months ago.
I think the borrower was the llc
Expert:  socrateaser replied 9 months ago.

Okay, thanks.

I am a member of the State Bar of California, the Bar of the U.S. District Court for the Central District of California, and a member of the California Association of Realtors. So, I appreciate that this issue concerns California law.

That said, your original question suggests that the client is an individual and that he was sued, and that the court awarded the LLC to the plaintiff to satisfy the judgment (though, I don't see quite how this works, from a pure legal viewpoint).

Your subsequent comments suggest that the LLC was sued. Consequently, I can't answer your question, because I don't know the actual parties in the case.

From what I can ascertain from your comments, my impression is that if the member lost the LLC in the lawsuit, then that is a 100% capital loss, identical to shares of stock that become worthless. The value of the loss would be the net value of the asset, which from what you've explained is zero. However, the date of the entry of judgment into the court register is the date of valuation, so that may or may not be true.

This is a very complicated issue. Without reviewing the actual court judgment, I'm somewhat "flying blind." But, I think that my analysis above is probably correct.

As for there being an COD income, the answer is no, if the LLC was awarded to the plaintiff, because, the member/defendant would have no ownership interest, and so no right to any income, phantom or real.

I hope I've answered your question. Please let me know if you require further clarification. And, please provide a positive feedback rating for my answer -- otherwise, I receive nothing for my efforts in your behalf.

Thanks again for using Justanswer!

Customer: replied 9 months ago.
You are right the llc was not sued, there was substantial value equity in the properties. My client thinks he should get a deduction for full value of the real estate inside the llc.
Customer: replied 9 months ago.
The balance of his capital account was negative
Expert:  socrateaser replied 9 months ago.

I think everything hinges on the fair market value of the LLC on the date that judgment was entered by the court, because that would be the date that your client's interest in the LLC was involuntarily converted.

If he had a negative balance in the LLC, then his loss was zero, so I don't see how he could possibly have a deduction for a capital loss.

Hope this helps clarify the issue.

Customer: replied 9 months ago.
The market value of the LLC would have been positive, but the tax basis of the capital account would have been negative. Does that have any bearing on your answer?
Expert:  socrateaser replied 9 months ago.

If the market value is positive, and the taxpayer suffers a 100% loss, then that's deductible (subject to the $3,000 annual maximum).

Customer: replied 9 months ago.
Lets use some real numbers. The value of the building with 7 million the balance of the loan was 5 million and the tax basis was 2 million.Are you saying that he would be able to deduct 2 million, the difference between the fair market value and the balance of the loan.
Expert:  socrateaser replied 9 months ago.

If on the date of entry of judgment, the taxpayer could have liquidated the LLC for $2 million dollars, then that's a deductible capital loss (though, the taxpayer may have many years of carry forward, because of the $3,000 capital loss limitation -- unless he has large capital gains to use as an offset).

Please don't ask me to try to figure out the inside-outside basis issues -- I'm a lawyer not a CPA -- so, you'll have to determine what the available tax loss may actually be.

Hope this helps.

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