401k Loan

[Snaggletooth]

Wife is getting out of a partnership. She is one-half of a partnership with a $200K loan. She and the other partner have jointly guaranteed the loan. Her basis has therefore been increased by $100K.

Due to losses and withdrawals, she only has $40K in basis left. She has been working on a deal for the bank to issue a new loan to the remaining partner only, and thus absolve herself of liability. This will require $80K from her, and the remaining partner is putting up the remainder.

She has a $20K capital loss, right? The $80K is added to increase her basis to $120K, and she is relieved of $100K debt liability. Simple math. $100K minus $120K is a negative $20K.

Not so fast. She is putting up the $80K from her husband's 401(k) retirement account. He is borrowing from the $300K deferred amount he has compiled over last 20 years. He will be required to pay this back, with interest.

NOW what is her loss (gain)?? Does the $80K count as basis since she has no basis in this money? What about the fact that her husband is paying back the $80K and not her?
(Her husband was also one of the guarantors of the partnership loan).

What say ye???

[Roland Slugg]

Dear Snaggletooth

Not sure I followed your post, but I'll offer some general comments.

First, she is NOT "putting up the $80K from her husband's 401(k) retirement account." That may be where the husband is getting funds that he, in turn, is providing to his wife, but it is irrelevant.

Second, when you say she has a basis of $40k in the partnership, are you including her 50% share of the $200k loan? I'm assuming you are, and that her capital account actually reflects a negative balance of ($60k). If her capital account is $40k before the liabilities are added, her basis is really $140k.

Next, when she contributes $80k to the partnership, her basis is increased by that amount. If her basis was indeed $40k, it then becomes $120k.

Finally, if the partnership then pays off the $200k loan, her basis goes down by 50% of that, or $100k, to $20k. If she then leaves the partnership, receiving nothing in exchange, she would have a loss of $20k.

Is this what's happening? Why is she walking away from $20k? I also wonder where the credit balance in her capital account will go when her account is closed. Is the FMV of other assets less than their book value? Does the $20k represent income to the remaining partner?

[Snaggletooth]

Sluggo

Roland, thanks for responding.

Her $40K basis is all that is left after losses and withdrawals. 50% of the $200K in loan guarantees has already been calculated in her basis.

My question really centered around the $80K being used to payoff the bank. Does it increase her basis from $40K to $120K? I think ordinarily the answer is "yes." But she and her husband are using $80K that they have no basis in, because it is part of his retirement account.

You seem to think that is irrelevant, and I tend to agree with you. Anytime money is borrowed, there is never any basis anyway. But in this case, he is borrowing against his retirement account, who is NOT going to tax him as a distribution. He's using money that has never been taxed.

Ironically enough, if he had taken out a conventional loan, and simply pledged $80K of his retirement account as collateral, this would be treated as a distribution.

Thanks, Snag

[Roland Slugg]

Dear Snag

Yes, it's irrelevant. The loan from H's 401(k) is a separate issue and will have to be repaid. If it isn't, it will become taxable upon default.

Only assets have basis. Debt has an affect on basis but doesn't have an actual basis of its own.