Partnership Loan

[Golden Rocket]

Facts: Larry, Moe, and Curly form a partnership with equal shares of contributions and income splitting. The partnership borrows $180,000, and predictably, the bank insists on personal guarantees from each partner. Each partner may thus add $60,000 to his basis.

After a couple years, the loan balance has been reduced to $150,000, but Curly feels like one of the partners is trying to poke his eyes out, and wants to leave the partnership. The settlement with the other partners exhonorates Curly from his responsibility on the loan, and the other two partners agree to repay the loan from ongoing partnership operations. Curly properly includes the liability relief with his settlement, computes gain or loss properly, and files on his Schedule D.

Curly is out, but as far as the bank is concerned, his exhonoration by the remaining two partners has not relieved Curly, as the loan was made subject to the guarantee of all three individuals. Subsequent disagreements by the parties have not altered the complexion or terms of the loan. The exhonoration by the two other partners was for partnership purposes only, and had nothing to do with the bank.

The partnership falls on hard times, and unable to pay the remaining $150,000. After suing all partners, Curly ends up paying $75,000 from his own funds.

Question: How and where does Curly deduct the $75,000 (or portion)? Amended the schedule D in the year of sale?

[S T]

Oh Businesses

Dont' you just "love it". Schedule C clients are so much easier than partnerships and S Corps!

Sandy

[Bees Knees]

Curly is out, but as far as the bank is concerned, his exhonoration by the remaining two partners has not relieved Curly, as the loan was made subject to the guarantee of all three individuals. Subsequent disagreements by the parties have not altered the complexion or terms of the loan. The exhonoration by the two other partners was for partnership purposes only, and had nothing to do with the bank.

The partnership falls on hard times, and unable to pay the remaining $150,000. After suing all partners, Curly ends up paying $75,000 from his own funds.

Question: How and where does Curly deduct the $75,000 (or portion)? Amended the schedule D in the year of sale?

Curly’s gain or loss at the time he sells his partnership interest in part is calculated based upon liability relief. If he is not completely relieved of liability at the time of sale, it cannot be considered a complete sale of his partnership interest.

I would say technically you should not make him pay tax on the gain attributed to liability relief at the time of sale since he was not relieved of any liability. Then a second gain or loss calculation is done at the end of the loan when all potential liability issues are resolved.

In reality, I doubt anyone would tell us or want to drag out the association with the partnership after selling his or her partnership interest. A personal guarantee doesn’t necessarily mean any money will actually have to be forked over to the bank years after the sale. Plus the selling partner isn’t going to know anything about partnership activity to determine his or her share of gain or loss based on liability relief. Therefore, even if it isn’t technically correct, I’d probably call it a complete sale at the time he sells his interest, and any loss due to the bank demanding more money later is a capital loss reported on Schedule D.