1231 property? - passive losses? - bad loan to RE

[pkmiller94]

Have a client who with 5 others lent $850K to a RE guy to buy an apartment building (which was vacant) - the intent was to earn 14% interest (they found this deal from a broker who advertise in the WSJ)

Of course the RE person did not make any payments - clients had to foreclose and they formed an LLC -

Now they have sold the building about a year after for 375000- (after back taxes etc, the net was about $200K) - so the actual cash loss was $650K

Now - no one need the capital losses - but everyone could use ordinary losses (as long if it is not passive) - one client we can put as active the rest are passive investors.

The group (not the same 5 guys) have done 3 of this type of deals.

I might be able to call the LLC (only one property in the LLC) an lender with a bad debt and a bad debt recovery. Showing an ordinary loss of $650K (but with only one active partner, and he is the tax matters partner) - so an other client who is passive complain to me that he does not have any passive income to offset. He started to tell me about the 1231 rules allowing them an ordinary loss to.

Any advice on the best way to handle these partnerships - I am preparing first year tax return for 3 LLC all with mostly the same issues - (one of the LLC did collect rents) - but all have huge losses.

[jainen]

>>the 1231 rules allowing them an ordinary loss<<

Yes, 1231 offers capital gains and ordinary losses. But I don't think this was 1231 property. Apparently it was never placed into service as a rental or any other kind of business.

The fact that it was held in one form of entity or another is not relevant. It might make a difference whether the investors transferred the note into the partnership, or the actual apartments after foreclosure. Either way, you will want to focus your research on how to determine the basis of property acquired by foreclosure--maybe it's FMV, allowing a non-business bad debt on the worthless loan.

One thing I don't recommend is deciding the correct tax treatment according to who needs what kind of benefit. That's called tax planning, and doesn't work very well after the fact.