Disposition of S Corp interest and passive loss carryforward

[David]

Taxpayer is a 25% shareholder in a family owned business. He did not materially participate in the buisness and has a $20K passive loss carryforward. 

His basis is $40K and he is departing without receiving anything for his shares. Therefore, he will show a $40K loss on schedule D.

He also sold a second home with a $150K gain.

Will he be able to recognize the $20K passive loss carryforward? Won't this be netted against the net $110K LT capital gain?

Thanks.

 

[Lee B]

Why is he departing without receiving anything ? If he doesn't receive anything how is he relinquishing his ownership of the shares?

If this was the final disposition of real property then of course the passive loss is released and available.

I am definitely interested to see how the rules apply so this situation.

[David]

The company isn't doing well and he says  the family (company) wouldn't be able to pay him for his basis. He just wants out.

 

[cred65]

Was the original issue of stock under Sec. 1244?

[David]

It appears that is is Sec. 1244 stock. However, I haven't seen the legal documents related to the issuance of the original shares. Do I need to see the paperwork related to the original issuance and does the paperwork have to say the stock is issued under Sec. 1244?

[cred65]

was an attorney involved in the incorporation?  Who has the incorporation records?

[jklcpa]

Also re: sec 1244:

• Is your client the original owner of the stock?  Code sec for 1244 doesn't say it, but it's in the regs that one must be the original owner of the stock in order to qualify.
• Second, make sure the company's receipts from other than the passive activities doesn't knock it out of the 1244 status, assuming it really does qualify.

 

 

[David]

TP is checking. He thinks his father was the sole proprietor of the business and his mother inherited the business after the father's death. The mother and kids set up the S Corp at that time, with the mother gifting shares to each child. 

[David]

If he just gets out of the business, doesn't receive any payment for his shares and the S Corp transfers them to treasury shares will he be able to claim the loss? Or is this considered a transfer of shares to a related party since the other S Corp shareholders are brothers and sisters? I would think this is not considered a transfer to a related party since the shares are going back into an S Corp.

If it is deemed as a transfer of shares to a related party then he won't be able to claim the loss or the take the passive loss carry forward amount.

Thanks for your help.

[Margaret CPA in OH]

What a timely discussion!  I have a new client who received stock in a divorce settlement recently.  I am now trying to determine whether 1244 (most likely) and then what to do when the ex states that most stock was purchased from joint funds but in his name and later stock was purchased for a higher basis.

Much reading to do and soon!  The tax ramifications are significant.

[jklcpa]

David and Margaret, here is an article from The Tax Advisor that has some information including some code and reg references, including a reference to the reg that states that the only person entitled to the sec 1244 treatment is the one who held the stock from the very beginning.  In reg. sec. 1.1244(a)-1(b) , see item 2 even though it is in the section for partnerships, the last portion of that reg says:

Quote

 In order to claim a deduction under section 1244 the individual, or the partnership, sustaining the loss must have continuously held the stock from the date of issuance. A corporation, trust, or estate is not entitled to ordinary loss treatment under section 1244 regardless of how the stock was acquired. An individual who acquires stock from a shareholder by purchase, gift, devise, or in any other manner is not entitled to an ordinary loss under section 1244 with respect to this stock.

Finally, here's a link to The Tax Advisor article: http://www.thetaxadviser.com/issues/2009/mar/claimingordinarylossesforsec1244stock.html

Margaret, try some research on that code and transfers of stock as property settlements incident to divorce. I don't have any firsthand experience to say whether there is any exception to the reg I posted or not.  ETA - Margaret, you're probably out of luck with your client's situation. I read this also, but don't have a reference at the moment: "Generally, all transfers of §1244 stock by the shareholder, whether in a taxable or nontaxable transaction, whether by death, gift, sale or exchange, terminate §1244 status."

Edited January 3, 2017 by jklcpa
ETA add'l info to Margaret

[David]

Thanks, Judy, for your help with this. I think I'm clear on the 1244 stock - I just need to hear back from the TP as to whether he was the original owner of the shares.

My question now (posted above) is whether giving the shares back to the family owned S Corp and not receiving payment for those shares, is considered transfer of shares to a related party. Since the shares are going back to the S Corp and not to a family member shareholder I would think this is deemed as a fully taxable transaction and not a transfer of shares to a related party.

Is my thinking correct on this?

Thanks.

[Margaret CPA in OH]

Thanks so much, Judy!  I was told that the shares were jointly owned having been bought with joint funds but I kinda, sorta doubt it.  As noted, I have much reading to do before calling the corporate attorney which I've permission to do and the attorney has permission to speak. 

I'm 'back to work' tomorrow and think my new client got cheated in this settlement but, hey, did she ask any tax person's advice ahead of time? No.  Does her attorney know anything about tax laws let alone 1244 stock.  I sincerely doubt it.  To boot, she has to pay her ex $12,000 per year as she 'makes' more money with her pension and Social Security so she has to sell stock every year.

Sigh, it won't be her happiest year.  I hope she can find some way to take this back to court.  Thanks again!

[DANRVAN]

4 hours ago, David said:

My question now (posted above) is whether giving the shares back to the family owned S Corp and not receiving payment for those shares, is considered transfer of shares to a related party. Since the shares are going back to the S

I believe your client should treat it as an abandonment per Reg 1.165-5 (I)(1)  "To abandon a security, a taxpayer must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for the security."

Reg 1.165-5(a)(1) defines a security as "A share of stock in a corporation".

Reg 1.165-5 (I)(1) Also states that an abandoned security is treated the same as a worthless security In that  "the resulting loss is treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset."

[Richcpaman]

Have the "S"-Corporation write a check for $1 per share to buy out the kids interest.   There is no "gift".  He sold the shares.

He would have a LTCL and Passive Loss to offset the other gain.

Rich

  

[David]

So is this considered a related party transaction?

[jklcpa]

54 minutes ago, David said:

So is this considered a related party transaction?

 

You should take a look at sec 267 for that.  A simple google search should bring up a lot of information. I usually gravitate to those from IRS, Cornell.edu, CCH first that I know are safe and reputable.

 

[DANRVAN]

3 hours ago, David said:

So is this considered a related party transaction?

Sorry I overlooked that part in my previous post. You will run into the Constructive Ownership rule found in section 267.. The abandonment could be treated as a sale to a related party, the corporation.