LLC interest - bad investment

Technical topics regarding tax preparation.
#1
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I posted this a few weeks ago titled "Origin of Claim." I was focused on the subsequent legal fees, but I need to wrap my head around this one.

I'm dealing with the wife of a deceased taxpayer. The details are a little fuzzy since the deceased never shared this investment with us or his wife, but this is the background I was able to gather from the attorney involved. No K-1s were issued,no 1099-C, nor anything else:

Back in 2007, the taxpayer invested $90k for an interest in an LLC. The LLC borrowed about $3 million to build apartments. He signed personally along with the other investors. Apparently the investment went bust. According to the attorney I spoke to, he had a chance to settle, but received bad legal advice from another attorney. In 2012, the lender successfully entered a judgement against the taxpayer for the $3 million (he was the only remaining investor who didn't settle). In early 2017, the taxpayer and spouse had over $500k debited from their joint checking account as part of the judgement. A few months later, the taxpayer died. His spouse spent about $400k in legal fees related to case, resulting in a settlement where no further money was due.

I received helpful responses on my other post, but I'm now focused on CODI and the $500k debit. I'm driving myself nuts on this. With this limited information, what are the tax consequences (CODI, Capital loss, etc.)?
 

#2
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To narrow my question: My now deceased client made the bad investment (originally $90k). The lender gets the judgment and his joint account is debited for the $500k in 2017 due to his signing personally and his bad legal advice. Do I take the $500k as a capital loss for 2017? Would the unpaid balance of $2.5 million be considered CODI? I want to double check on a previous response from another post.
 

#3
JAD  
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I'm trying to wrap my head around this. On 10/15/19, when 2018 returns are due, you are asking about 2017 issues, large amounts, no preliminary indication of where your research has lead you?

You say the details are a little fuzzy. Is that what you are going to say to an auditor? You need to know everything about this investment.

2007 - invested $90,000 in a LLC. Get the K-1s, you need to account for his capital account, determine if there are suspended losses (passive, basis, at-risk - probably not for the latter 2 since it sounds like the debt was recourse to him)

How much did he spend on the first attorney? Should those fees have been deductible when spent or capitalized? If the former, has the SOL ran? If the latter, account for accordingly.

The LLC borrowed $3M and your guy wound up having to pay the whole thing? Does he have recourse against the other members? If so, how does that impact the timing and determination of the loss. What is the impact if W decides not to pursue the others?

$500k came out of the bank - is that in final settlement?

$400k additional attys fees spent by wife. Again, how to treat? (clue: origin of claim, lots of threads here on this issue)

Finally, you wrote, "I want to check on a previous response from another post". You mean that you want to get some ideas on where to go with your research on these issues, right? You are not preparing a tax return with these complicated issues and significant amounts based solely upon these discussions, right? TPT is not substantial authority.
 

#4
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In a perfect world, I would know all the details. I was planning on amending 2017, so I would take the carryover on 2018 (rather than amending later). I think we've all dealt with situations where it's virtually impossible to get information. I'm dealing with a dead guy who invested in what was probably a BS investment. Attorneys have vague details on the underlying investment.
Original investment is well past SOL. The $500k was what was in the account, but the $400k in subsequent legal fees post death stopped the lender from pursuing the balance. I checked posts on origin of claim, but nothing relevant. I think most people come here for some guidance, not a substantial authority.
 

#5
JAD  
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Yes, guidance, not substantial authority. But you said that you were trying to double check a response from a previous post...you have several potential technical issues here.

I think we've all dealt with situations where it's virtually impossible to get information.

Yes, the basis of antiques acquired in the 1920s for a client who died in 2010, when the step-up in basis rules did not necessarily apply, and we were using the rules that existed for the one year, so the property's basis carried over to become the basis for the beneficiaries of the estate.

This is not that long ago. Information is available - copies of returns from the IRS, etc. I would not move forward without the data. Hopefully I've at least given you a bump, and someone with better ideas will come along.
 

#6
Nilodop  
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Yes, it would be great to have all the facts neatly tied up in a ribbon. But OP doesn't, and he'd be the one to track them down as best it can be done. Meanwhile, JAD has listed most if not all of what OP needs to consider. But maybe we can help a bit on some of the issues. Especially the potential for COD income of $2.5 million! OP expresses it like so: Do I take the $500k as a capital loss for 2017? Would the unpaid balance of $2.5 million be considered CODI?

Back awhile ago, I asked about whether cancellation, forgiveness, settlement, whatever, of a big judgment against someone creates COD income. Here's the thread. viewtopic.php?f=8&t=15858&hilit=+cod. Jeff-Ohio jumped in and enlightened me (us, I suspect) on the topic. See posts #21 and 22, and the link in 22. I think they establish that the $2.5 million is not COD income. Do you agree, OP?
 

#7
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Yeah, a lot of questions here. The relevant Regulation is 1.166-9. It’s not very long.

Don’t think we’d have any direct COD at the personal level as a result of the judgement exceeding $500k and then the balance of the judgement later being charged off. But the the guy died. Thus, any COD aspect associated with the excess judgement would be at the estate level, I’m guessing. But again, I really don’t think there would be any associated with the judgement. I think where the COD might hit is on a K1 and that would be unrelated to the guarantee per se. It sounds like the guy never received a single K1. And if COD were to hit on a K1, I really have no idea what the amount would be, if any. There’s a lot of accounting and analysis that would have to take place at the partnership level. Was there a foreclosure? What about partnership’s basis? Was the debt even forgiven as to the partnership? Was the debt recourse or nonrecourse to the partnership? Note that Sec 752 doesn’t govern this latter determination. If it was non-recourse to the partnership, then the partnership’s accounting would treat the debt as proceeds from a deemed sale. See this, as to that point:

https://www.thetaxadviser.com/issues/20 ... ncome.html

As you can see, I’m assuming this is a partnership, although you didn’t say.

So, as to the “partnership” issues, the attendant accounting and K1’s, etc…sounds like we have zero information. But who knows if the partnership even filed returns. Sounds like you’re completely ignoring the partnership aspect of things. It might be that we end up there, but I’m simply raising some questions, as others have done.

If we do end up ignoring the partnership aspect of things, the IRS would have to prove there is some income there.

JAD said this:

Does he have recourse against the other members? If so, how does that impact the timing and determination of the loss. What is the impact if W decides not to pursue the others?


That idea is part of the above referenced regulation in (e)(2). I have no idea if this guy has a claim against the other partners. Perhaps the attorneys know, since they received $400k from the guy’s wife. In addition, the IRS could say this: “You haven’t proven that the partnership had $0 assets. As a result, you haven’t proven that your debt is worthless.”

If you’re comfortable with proceeding, even though this line of attack is hanging out there, along with a lot of related unknowns, then it seems to me, you’d take a business bad debt deduction for the money that was seized from the client. The legal fees would follow that treatment. I think the issue there is whether or not any should be capitalized, but I doubt it. If that’s the case, and if wife paid the fees in more than one year, they would be deductible in those years.

You say that in a perfect world you would know all the details. You also need to realize that in an imperfect world, such as the one you’re apparently in, there are certain risks you run which will materialize if the IRS starts asking any questions.

I’m not sure what tax impact this big deduction, if you choose to claim it. Will it wipe out the couple’s 2017 income? You also need to think about what might happen if an NOL is created by a guy who died in 2017…and whether or not that NOL can be carried back and/or forward. You can go back. But if there is any carryforward coming into 2018, seems it expires with the husband.
 

#8
jon  
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I love to guess: Depending on basis loses were passed through or carried forwarded; If losses were taken then payment brings basis back fro negative (maybe); if loss was carried forward because of basis now you get the loss. The reporting of the LLC should get you to the individual return, I do not think a current payment changes the reporting for 2017. If you end up with a positive basis after all the above you have a loss and I would take it as ordinary.

Banks and taxing authorities tend to go get money from guarantees and take it from where it is the easiest to get. I have seen attempts and some success of getting money fro other guarantees who avoided their amounts.
 

#9
Nilodop  
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As you can see, I’m assuming this is a partnership, although you didn’t say.. Yikes, I too assumed partnership. Easy trap into which to fall.
 


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