How to write off LLC investment in startup

[strabun]

I've been a passive member of an LLC investment since 2010, and for years the company hasn't had any material change in their business.  My annual K-1 always has 0 in box 1, and TurboTax has carried forward a passive loss of -$5002 (box 1 - ordinary income) and -$857 (non-portfolio long-term capital loss).  

I would like to write this investment of $5000 off, since I believe it is worthless.  But I need to know exactly how to do this in Turbotax. 

Thank you in advance for your assistance!

[Mike9241]

it is important to know why the LLC has not terminated and filed a final return and K-1s.  if it is still operating it might be difficult to prove to the IRS that your investment is totally worthless.  it may be that under the LLC agreement you don't get any further allocation of loss.     

[strabun]

I understand and agree. However, other investors in this startup have told me that they have written off their investments for tax purposes, so I thought I would ask how to do it in TurboTax. I have reached out to the private equity firm that has a controlling interest to see if there is a way for me to sell my shares or abandon my investment. I just don’t know the best way to handle it, and would benefit from the write off this year. 

[Mike9241]

use this thread below in helping you to determine whether your entitled to take your loss. it's limited to your  1) original investment plus 2) any income included in your tax returns over the years plus 3) any tax-exempt income over the years  less 3) any losses deductible on your tax returns (does not included suspended passive losses) over the years less 4) any distributions received over the years less 5) any expenses under the tax laws that would not be deductible such as travel and entertainment (this does not include suspended passive losses).  the result is your "basis". 

**********

if you conclude that a writeoff is proper then you indicate in Turbotax that the current year is a final year and you've disposed of your entire interest.  this will allow the suspended passive losses to pass through. if the losses exceed your "basis" you'll have to use the at-risk form 6198 to limit the deduction to your "basis"

*********

https://www.thetaxadviser.com/issues/2020/may/deduction-worthless-partnership-interest.html 

while this refers to a partnership it would also be applicable to an investment in an S-Corp 

[strabun]

Mike,

I really appreciate you taking time to answer my question.  I've read the article that you shared, and believe that I can justify this investment is worthless.  I could really use some specific TurboTax assistance on how to write this off so that the passive losses pass through.  When I select "disposed of a portion of my partnership interest in 202x", do I then select "abandoned partnership interest"? Assuming this is the case, I enter the purchase date and "sale date".  My cost basis is $5000, so on the next "enter sale information" screen, do I enter $0 for sales price, and $5,000 in the partnership basis fields?  And since I don't expect that the K-1 will actually show anything different than in previous years, how do I force TurboTax to actually pass through the passive loss?  Any specific guidance on how to navigate TurboTax to accomplish this would be greatly appreciated!

[Mike9241]

reread my prior post it tells you how to get the losses to flow through subject to any at-risk limitation.

as I understand your prior thread you have suspended passive losses of over $5000 while your investment was only $5000. all you can deduct is $5000 of the passive losses. YOU DO NOT GET BOTH YOUR PASSIVE LOSSES AS A DEDUCTION AND YOUR INVESTMENT. THAT'S WHAT IS REFERRED TO AS DOUBLE DIPPING WHICH THE IRS FRIOWNS ON AND FOR WHICH THE IRS CAN IMPOSE PENALTIES BESIDES THE TAXES AND INTEEST

again check final k-1

again check sold/disposed of entire interest

on disposal screen

check complete disposition

check abandoned partnership interest

disposal date 12/31/2022

sales price 0

basis 0

doing this should allow the suspended passive losses to flow though.  however, I have not figured out how to limit your losses to the $5000.   probably because either the at-risk form was not completed in prior years or there was debt (part ii section k) that was used to increase your basis but now that debt is gone which triggers income recapture.  the income recapture would be equivalent to or should be equivalent to the negative amount in Part II schedule L ending capital. 

[AmeliesUncle]

The deduction applies to the year that it "became" worthless.

Was there something that happened that made you decide it "became" worthless this year?

If it "became" worthless in a prior year, you would need to amend that year to claim the loss.

[strabun]

Mike,

To clarify, I'm planning to write this investment off in the 2023 tax year, but am using a copy of my 2022 TurboTax return to "test" how this will work when I file early next year (if that makes sense).  

My goal is to report a $5,000 ordinary loss on the $5,000 investment made in 2010.  I have not materially particpated in the operation.

Reporting as abandoned interest, and leaving the sales price and basis as zero does not do anything with the passive loss in TurboTax.  I was expecting to see a $5,000 loss showing up on Schedule D, line 12 - "net long-term gain (loss) from partnerships, s-corporations, estates, and trusts from Schedule K-1's".  I'm just not sure how to get Turbotax to turn the passive loss into an ordinary loss.  

Turbotax help dialog box says "There is another way to turn passive losses into ordinary losses that will become fully deductible: When you completely dispose of a passive activity there is a final accounting of whether you actually made or lost money on this investment.  See completely disposed".

When I open that dialog box, it says:

"DISPOSITION OF AN ENTIRE INTEREST

If you disposed of your entire interest in a passive activity or a former passive activity to an unrelated person in a fully taxable transaction during the tax year, your losses allocable to the activity for the year are not limited by the passive loss rules and any passive loss carryovers are allowed in full. A fully taxable transaction is a transaction in which you recognize all of your realized gain or loss.

If a passive activity or former passive activity is involved in a like-kind exchange, the activity should NOT be considered fully disposed of and current year losses and passive carryovers are still subject to the passive activity loss rules.

If you are using the installment method to report this kind of disposition, figure your allowed loss for the current year by multiplying your overall loss (which DOES NOT include losses allowed in prior years) by the following fraction:

Gain recognized in the current year
-----------------------------------------------------
Unrecognized gain as of the beginning of the current year

A partner in a publicly traded partnership (PTP) is not treated as having disposed of an entire interest in an activity of a PTP until there is a complete disposition of the partner's entire interest in the PTP."

Thoughts?  And thank you again for taking time to assist me, I really appreciate it!!!

[strabun]

Although the LLC continues to send me K-1's every year, they are non-responsive to any requests I have made about the status of the company, and my desire to dispose of my interest in the company.  Other individuals who have invested in the company have previously written off their investments for tax purposes.  I'm just trying to figure out how to get TurboTax to turn my passive loss carryover into an ordinary loss so that I can be done with this investment.

[AmeliesUncle]

---

@strabun wrote:

does not do anything with the passive loss in TurboTax.

Did you check that it was a "Final" K-1?

[strabun]

I do not see an option or selection in TurboTax 2022 for "Final K-1".  But if I select "This Partnership ended in 2022", then I can select complete disposition, followed by abandoned partnership interest.  Looks like this may have answered my question.  It put the $5000 loss into Schedule E and then shows up on line 8 of my 1040 (other income from schedule 1).

Thank you!!!

Steve

[Mike9241]

if the suspended passive loss was ordinary, it will now flow to schedule E page 2.  and your choice in "picking 2023" may be an issue that the IRS could challenge. 

The subjective component relates to the important question of when a property becomes worthless. A taxpayer is entitled to exercise judgment and discretion in determining when an asset has become worthless to him or her, even if someone else might have considered the asset in question virtually valueless in a prior year or might have been willing to gamble that the value could be restored in a future year. The taxpayer's subjective determination of worthlessness must be accompanied by a reasonable showing that the asset was in fact essentially valueless at the time selected by the taxpayer, as confirmed by objective evidence.

in other words, if the evidence shows it was worthless in some other open year that's the year for the write off. if it's a closed year you essentially can be denied any deduction. 

[strabun]

Mike,

This is very helpful.  I figured out how to navigate TurboTax.  Once I selected "the partnership ended in 202x", followed by "complete disposition", and "abandoned partner interest", it all flowed correctly in my TurboTax "test" scenario.  

I believe that other investors have been arbitrary in their timing for writing off their investments in this company.  I have requested an investor update, and have asked if and how I can sell or dispose my interest in the company. I will be curious what their response will be, but at least I have documentation to support my desire to get out of this investment.  I would think that after 10+ years of no activity, I have sufficient justification to consider it worthless.

Mike, I really appreciate you taking so much time and provide great advice on this!!

Steve

[Rick19744]

I will add a few comments:

• Just reiterating what has been mentioned, but it is a critical component, in order to be able to prevail in a worthless investment deduction, this deduction must be taken in the appropriate year.
• Your facts indicate that others wrote off the investment in other years, and you are now wanting to write this off in 2023.  If audited, you will need to be able to support your position as to why 2023 and not an earlier year, or for that matter, see bullet 4.  Just because others have taken a worthless investment deduction in the past, does not mean that the investment is truly worthless.  It just means that there was no trigger for an audit, and not having to support their position.  
• I'm not sure after 10 years I would call this entity a start-up.  Regardless, you are actually receiving K-1's.  Are the other investors that wrote off the investment also still receiving K-1's?
• Bullet 3 could be a key component.  While you may not be currently (nor in the past) receiving any income, deduction, etc., what would happen upon a liquidation of the LLC?  Would you receive any proceeds in a liquidating distribution?
• As a member, you should ask for a copy of the financial statements.  What does the balance sheet look like?  This would be a key factor in being able to support a worthless investment deduction.
• Take this slowly and make sure that you have the documentation to support a worthless investment deduction for 2023 if that is what you decide.

[strabun]

Rick,

Thank you so very much for your comments.  You make very good points and I will attempt to obtain more information from the company so that I can make a decision about what to do.  I certainly do not want to risk being audited.  Thank you again!

Steve