Computing stock and debt basis when stock is sold during the year.

• Author: Ellentuck, Albert B.

Facts: William, who has been the sole shareholder of Esscorp for several years, materially participates in its operations. His stock basis at the beginning of the corporation's calendar tax year was zero. There were no loans payable to William at that time, and he has a suspended passthrough loss (due to lack of basis) of $15,000 from prior years.

During the current year, the following transactions occurred:

* January 2: William made a capital contribution of $10,000.

* January 15: William loaned the corporation $45,000.

* March 15: The corporation made a $12,500 payment on the January 15 note, reducing the unpaid note balance to $32,500.

* July 1: William sold all of his stock in Esscorp for $39,000.

* July 15: Esscorp paid William the remaining balance ($32,500) of the January 15 note.

The corporation reported a loss for the year, and William's share of the loss was $17,000. Issue: Can William use his basis in stock and loans to deduct ordinary losses in the year of complete termination of his interest? What amount can William deduct as suspended and as current passthrough losses on his income tax return? What is his gain on the stock sale and on the note repayment?

Analysis

First, William's basis in stock and debt must be computed. Normally, the adjusted basis of a shareholder's stock is determined as of the close of the corporate tax year; the adjusted basis of stock sold or otherwise disposed of during the year is determined immediately before the sale or other disposition (Regs. Sec. 1.1367-1(d)(1)). The same premise applies to the basis of debt owed to the shareholder. Debt basis usually is determined as of the close of the corporate tax year; however, if the shareholder is not a shareholder as of the close of the tax year, debt basis is determined as of the last day that stock was owned (Regs. Sec. 1.1367-2(d)(1)).

Exhibit 1 shows how to calculate William's stock and debt basis as of the sale date.

Exhibit 1: Basis Calculation Stock Debt Basis, beginning of year $ -- $ -- Capital contribution 10,000 Loan to corporation -- 45,000 Less: payments on loan through June 30 -- (12,500) Basis before adjustment for income or loss $ 10,000 32,500 Current loss (10,000) (7,000) Basis before adjustment for carryover loss -- 25,500 Loss carryover (15,000) Basis, date of stock sale $ -- $ 10,500 William has sufficient basis to deduct all $32,000 of the losses ($17,000 loss from the current year+ $15,000 carryover loss). He will report a long-term...