Guaranteed loans

[Snaggletooth]

Here is a good "basis" question.

S corp has a 60% shareholder. Corporation is worth considerable more than its
book value. This shareholder's tax basis is $100,000 excluding any loan factors.
The $100,000 basis is the conventional calculation: original investment plus taxable
earnings minus dividends, etc.

Shareholder sells on 12/31/06, for $1 million. Capital gains of $900,000, right?

Well, hold on. Corporation has numerous loans on its books, most notably
$700,000 for equipment. Corporation has existed for 12 years, and during this
time has had loans fluctuating between $400,000 and $800,000 for the last
several years. Corporation is solvent, has never defaulted, and there is no reason
to believe its debt will not be paid.

Here's the catch. The 60% shareholder has had to personally guarantee the
corporation's indebtedness since corp was founded. The $700,000 note payable
on the books of the corporation at the time of the sale, also has the signature
of this shareholder as a surety. Note: loan is officially made to the corporation,
not to shareholder. Shareholder is surety only.

Question: Does the $700,000 guarantee get added to the shareholders' basis?
i.e. basis is increased from $100K to $800K by virtue of the surety?? This reduces
the capital gain to $200K.

This may appear reasonable at first glance. However, let's assume the shareholders
Schedule D shows this $200K capital gain on his 2006 return. But then what happens
when the corporation pays off the $700K debt? Shareholder is claiming basis that
he never contributed, and was never consummated.

How 'bout it, folks????

[outwest]

Real simple answer..

unlike a partnership, mere guarantee of a S Corp loan does not create basis.

TTB 19-7

IRC 1366(d)(1)(A) requires direct loans to corp from the shareholder to create basis.

[dsi]

Let's see now, is the corp selling the assets or is the SH selling his stock?

[Snaggletooth]

dsi

Thanks for responding. The shareholder is selling his shares to another party.

[OldJack]

As "Outwest" as accurately stated with references, "unlike a partnership, mere guarantee of a S Corp loan does not create basis." This is a no-brainer fact that has been around forever.

The seller has a $900,000 gain to report on his 1040.

The question on how to handle payments the seller makes if required to make good on the guarantee is that he has a business deduction (1040, Sch-E, page 2, the same as where he reports income from the S-corp) for such payments in the year that any payments are made.

[Porat]

Guaranteed loans

The Shareholder wouldn't have basis on the loans guaranteed unless he made payments on the loans. Minter case

[JON]

Who the heck

would sell the stock but leave a surety for a loan in place???? No basis possible -unless it was incurred before the law change, but if they have been changing terms that would kick it out anyway.... If they default on payments does he get the company back? I am assuming he is getting cashed out on his stock.

[Snaggletooth]

Two Responses

First to Porat - (less fortunate cousin to Rich Rat, mebbe?) Notice it is your 2nd registered post, and want to take the opportunity to welcome you to the board. Lots of good stuff going on here -- taxes, fun, old fogeys, etc.

And to Jon - excellent observations, all. What appears to be stupidity may in fact turn out to be exactly that. But the "why" is quickly answered when you mention the word "relative."