Reporting a business loan loss made by an LLC

[GGBJr]

My daughter runs a single-member LLC which made a $22,000 loan to another business.  That business has folded, but repaid $12,000 to her LLC before folding.  How does her LLC report the $10,000 loss?  Does she have to add an attachment to her return describing the loss?  Can the return still be e-filed (since it is a very large return)?

[Mike9241 · Accepted solution]

If there was no business purpose for the loan, it is a non-business bad debt which would be reported as a short-term capital loss.  If there was a business purpose, record it as a business bad debt on schedule C. Hopefully, if it's a business loan she has documentation to prove it.  For a nonbusiness loan, all she would need is documentation the loan was made. Without proper documentation she faces disallowance if audited.  

[GGBJr]

Thanks for the prompt response.  It was a business loan made to a sub, owned also by her, so it will be tricky documenting the loan.  However, if Schedule C is used, I presume that e-filing will not be a problem?  Does a separate document have to be attached to the return?

[Mike9241]

What happened to the sub and what type of entity was it?  Now that you point out that it's between related parties (EXTREMELY IMPORTANT),  her, her business (schedule C)  and the sub(?) there is no deductible loss on her schedule C. The loan would be treated as a direct loan from her to that sub and thus becomes part of her tax basis in that entity. 

To clarify a single-member LLC is a disregarded entity for tax purposes so the loan is between her and her sub(?) which is also her.  Assuming the sub also went out of business and there was no cash or other assets left to repay the "loan" then the loss of that money is reflected in the loss of the sub. So a write-off on her schedule C would be double dipping. If the sub is still in existence then the loan is like the money she put in directly so she looks to that entity for the eventual repayment. 

The answer I previously gave was a loan between unrelated entities. 

[GGBJr]

Many thanks for your detailed responses.

My daughter's main LLC business is the rental of an apartment unit.  She took $20,000 in funds from this LLC to set up a retailing entity as another LLC, which is the LLC that has been shut down. There is not a formal loan contract.  The apartment-related LLC received $12,000 from the retail LLC in payment for the loan before it went out of business.  The retail LLC defaulted on the $10,000 remainder.

Since this was a business transaction, it would seem that the loss on the loan would be equivalent to a business expense.  If she can document the use of the loan money coming from the apartment LLC for the purchase of retail goods for the retail LLC, would that not qualify indirectly as a loan?

Sorry for such a messy situation!

[RobertB4444]

It's not a business transaction.  She loaned the money to herself.  In addition, she is taking an expense for the purchase of the inventory for the sub.  That's where the expense is.  If she were to take a loss on her other business then she would be taking credit for the expense twice as @Mike9241 says above.

This isn't messy.  Unfortunately she loaned the money to herself.  There is no business expense for that.  (Even though she used it for a business purpose.)

@GGBJr 

[GGBJr]

The key appears to be that the loan is not from an outsider.  If a bank made the loan to the retail LLC, then I imagine that the bank could take the loss on the loan for tax purposes.  But, because my daughter took personal funds and loaned it to the retail LLC, she is not eligible to take the loss.

Thanks for responding, regardless!

[Mike9241]

An LLC is deregarded for tax purposes so it was her rather than her other LLC that loaned the money to her retail LLC.  What did the retail LLC do with the money?  Probably used it to buy inventory or other assets or pay expenses. Thus she's getting a deduction for the loan when the items are expensed or she gets a deduction for the expenses the retail LLC paid. 

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From an income/loss standpoint, which is not in conformity with the tax laws,  if she were to take a write-off on the first LLC, then the retail LLC would have an equal amount of debt forgiveness income so the items would wash.    

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If a  bank made the loan directly to the retail LLC and she could not repay it, she would have forgiveness of debt income unless bankrupt. However, at the retail LLC level that money was used for something that would have produced expenses/loss in an equal amount so she would get the write-off from the retail LLC. In this case the write-off from the retail LLC would be canceled out by the forgiveness of debt income. again a net of ZERO.

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If you need further clarification consult an outside tax professional.

[GGBJr]

Appreciate the detail.  From an accounting perspective I'm glad the retail LLC has disappeared!  We at the unwashed level are fortunate (via TT) to have folks such as yourself who can keep us on the straight and narrow.

Many thanks!