loan from an LLC member to an LLC

[SeattleDrzl]

my business partner and I both made loans of equal amounts to our LLC  to purchase computer equipment necessary for the business. For a while business was good and we were able to get a small portion of our loans repaid (with interest) however things got bad and eventually the company failed and the equipment became worthless.

Question: on my personal tax filing can I treat the unpaid portion of the loan as business related bad debt and claim it as ordinary losses? If so , do I have to claim the full amount the year the LLC got dissolved or I can carry part of it forward?

[Mike9241]

assuming the entire amount of the loans went to purchase equipment, you get no write-off for the loans. what you can write off is the remaining tax basis of the equipment, if any. have you been filing partnership returns?

here's an example that might clarify why the loans aren't a write off

you (invest) loan the LLC $50. which gives you $50 of tax basis. 

the LLC buys $50 worth of equipment. this has no effect on your tax basis

you take $50 of depreciation on the equipment. this reduces your tax basis to $0. so no further write-off is available. if only $40 of depreciation was taken and the equipment is worthless, the remaining $10 could be written off.  in either case, you put in $50 and took write-offs of $50 

you have to determine your tax basis in the LLC. if it's greater than $0 then it has something that has a tax basis greater than $0. if it's worthless it can be written off and the loss passes through to you on the k-1 for the partnership return. if somehow there is a negative basis, you wrote off more than was allowed. see a tax pro.

if you have not been filing partnership returns, consult a tax pro. penalties for failure to file can be as much as $5,000 for each return not filed.

[SeattleDrzl]

Thanks for your input.

Yes we filed partnership returns. 

From your answer, I guess a capital investment and a loan are treated the same?

Is it because we loaned the money to the LLC that we own?

Would it be different if we have lent to an LLC that we did not own? 

I am asking because We had an initial capital investment in the LLC that we used to purchase equipment. Then we needed extra funds so we made a loan to the LLC. Those extra funds went into infrastructure, operations and additional equipment.

[tagteam]

---

@SeattleDrzl wrote:

.....I guess a capital investment and a loan are treated the same?

---

Capital contributions and loans are treated differently.

See https://www.thetaxadviser.com/issues/2018/oct/loans-members-llcs.html

[SeattleDrzl]

I read that article, it leads you believe that the bad debt can be claimed as an ordinary loss.

What am I missing?

[tagteam]

You are not missing anything except that there is an inside basis and an outside basis.

Read @Mike9241's post again.

Does the LLC still own the equipment? Was the equipment sold to a third party or distributed to the members? Was the equipment scrapped? 

[SeattleDrzl]

the equipment is scrapped

[tagteam]

If the LLC now owns nothing (i.e., equipment, et al) and has been dissolved with no distributions to the members, then you need to calculate your basis. 

To the extent you have basis, you have a realized loss which you can recognize on your return. 

[SeattleDrzl]

So all this is captured in the K1?

[tagteam]

You need all of your K-1s (unless you have this documented elsewhere) to calculate your basis.

Your basis is increased and decreased by certain items (see link below for list).

https://www.irs.gov/publications/p541#en_US_202102_publink1000104288

A basis worksheet is available at the link below.

https://www.irs.gov/pub/irs-pdf/i1065sk1.pdf

[Mike9241]

Thanks for your input.

Yes we filed partnership returns.

From your answer, I guess a capital investment and a loan are treated the same? from a tax standpoint there's not really a difference between a capital contribution and a loan in regards to an LLC. 

HERE'S A LINK TO A PARTNERSHIP BASIS COMPUTATION WORKSHEET

https://tax.thomsonreuters.com/content/dam/ewp-m/documents/tax/en/pdf/other/quickfinder-updates/qpep... 

Is it because we loaned the money to the LLC that we own? yes

Would it be different if we have lent to an LLC that we did not own? IN SUCH A SITUATION WHICH IS NOT THE CASE HERE THERE WOULD BE A SUBSTANTIAL DIFFERNCE IN THE TAX TREATMENT OF UNCOLLECTIBLE LOANS BECAUSE LOSSES OF THAT LLC WOULD NOT REDUCE YOUR BASIS IN THE LOANS SIMPLY BECAUSE YOU ARE NOT A PARTNER (OWNER) BUT A LENDER. THUS A NON-BUSINESS BAD DEBT 

I am asking because We had an initial capital investment in the LLC that we used to purchase equipment. Then we needed extra funds so we made a loan to the LLC. Those extra funds went into infrastructure, operations and additional equipment.   AS NOTED ABOVE THIS IS ONE LLC TO WHICH YOU ORIGINALLY MADE AN INVESTMENT AND THEN BECAUSE IT NEEDED MORE MONEY MADE A LOAN WHICH WAS REALLY AN ADDITIONAL INVESTMENT.

IN YOUR SITUATION THERE WOULD SEEM TO BE NO DIFFERENCE BETWEEN INSIDE AND OUTSIDE BASIS. 

IN ANY CASE, SINCE IT SEEMS NO PROPERTY WAS CONTRIBUTED ONLY CASH IN THE FORM OF INVESTMENT AND LOANS, YOUR BASIS IS THE ORIGINAL AMOUNT INVESTED + ANY ADDITIONAL AMOUNT INVESTED + LOANS - DISTRIBUTIONS - LOAN REPAYMENTS - LOSSES.  

IF WE WERE TO LOOK AT THE BALANCE SHEET ASSUMING ALL ASSETS WERE EXPENSED OR DISTRIBUTED (ASSET DISTRIBUTIONS OTHER THAN CASH CAN HAVE TAX ISSUES)  WE WOULD LIKELY SEE PAGE 5 COLUMN D TOTAL ASSETS = $0 AND COLUMN D LINE 19A IN THE AMOUNT OF X

AND LINE 21 (X) -X SO THAT LINE 22 WOULD ALSO BE $0

[SeattleDrzl]

Thank you so much I appreciate your help and the clear explanation. 

[rjhowell]

Looking for bad debt write-off guidance

[JamesG1]

Are you referring to a nonbusiness debt or a business related debt? 

Nonbusiness bad debts are treated as short-term capital losses in the year the debt became worthless. You claim a bad debt in Part I of Form 8949.  You must attach a statement to the form providing details about the bad debt, which include the following:

• The name of the debtor and your relationship to that person.
• The amount of the debt and when it was due.
• The efforts you made to collect the debt.
• The reason you believe the debt to be worthless/uncollectible.

Or are you referring to a loan between a partner and the partnership?  Please clarify.  Also review Mike9241 explanation of outside basis above.