Discussion:COD from Related Party Installment Note

Real Estate developer client's tax strategy during time of huge real estate appreciation was to own investment land in an LLC for at least a year, then sell it to a related party S-Corp developer, thus capturing as capital gains all apprecation from land purchase through beginning of lot development, which was quite significant from 2002 through 2006.

Sales from LLC to S-Corp (identical ownership of 2 entities by attribution)were done on installment, and payments were made to the LLC as S-Corp sold the individual lots, with taxable gains reported by the LLC accordingly.

Well, now obviously, times have changes. S-Corp is selling lots for a fraction of what they paid the LLC for them.

I'm trying to help them decide the timing and amount of installment debt to forgive, and what the tax ramifications will be.

What entry does the LLC make on debt forgiveness. For instance, if $300K of the note is forgiven, and there are still deferred gains of $225K, how is the remainging $75K treated. What if recognized taxable gains on installment receipts during the life of the loan have been $75K? Does that somehow factor in - as in a $75K capital loss {reverse recapture??}?

And what of the S-Corp. What would be the credit to offset the debit of the remaining installment note payable? I assume it's a credit to COD income, but it also seems the land inventory should be reduced to reflect what actual cost of the inventory was??

Sorry, I know that's a lot of questions, but I've never dealt with a transaction like this before. I'm guessing this won't be the last.

TIA

I'm more concerned, though about the journal entries for these transactions. The LLC would credit the Installment Note Receivable, but what is the debit entry? I assume it's the remaining deferred tax liability, but what if the written off debt exceeds the def tax liability? Is the remaining debit a capital loss???

And for the S-Corp that treats the real estate as inventory, I suppose the credit is "COD income", though nontaxable as the client is insolvent. Does inventory not get reduced?

Thanks again.

See the rules about that.

And I charge alot for that comment. Alot...

The tax savings can be huge.