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Expert: Richard Fritzler — 1/25/2010

Question

Hello Richard,

In 2004 I invested $15,000 in a start-up company (LLC). I bought 1/8 of one-point for the price of $15,000. The paperwork shows that I was a partner or investor in the company. The company never went public or listed on the stock market. The company was to manufacture a newly invented kitchen appliance. There were some sales but none of the investors ever received any profits, dividends or revenue at all. For a couple years we received K-1 which always showed a loss. I always entered the K-1’s on my tax return but they never affected my refund in any way. In 2009 the company went into Chapter 7 bankruptcy, went out of business and closed for good the same year. I contacted the lawyer who handled the bankruptcy to inquire about any paperwork the investors were suppose to send out in order to claim the loss on our taxes. I was informed by the lawyer that the company maintained very poor financial records, coupled with the fact that there was no money left for any accounting work, that there would be no records sent out. The lawyer also informed me that the K-1’s we received in prior years contained serious errors. Hence, a double- hit for the bad investment. I was told by someone else that I was suppose to receive a 1099-B showing the total loss of my investment. My question is two-parts; 1) How do I take the $15,000 loss on my taxes? 2) Is it a $3,000 per year loss for five years of tax returns? Additionally, I am also worried that since we never received any 1099-B or whatever paperwork, and since the IRS never received anything, when I claim a loss on my tax return will this trigger an audit? Thank you very much for your time.

Answer

If your records are accurate (you have memorialized the purchase of the stock, the amount paid, etc.) and you have the letter that the business is closed and there are no assets, then you can claim the loss.

Will you audited? I can’t say with certainty, nor can anyone else. Whether it is the; change in personal income; the claiming of unusual deductions; a policy change; Math that didn’t make sense; someone whispered in someone elses ear; etc, any of these might be the catalyst for an audit.

If there is a question about the validity of your tax return, it quite often was because you broke profile there was a change that makes you now unusual, and the computer kicked your tax return out as one to review. this would then be given to a person, if that person can figure it out and make the correction then you won’t here anything about it. If there are still unanswered questions then the normal next step is a Letter of Inquiry or what I affectionately refer to as a nastygram from the IRS. IF you can resolve the question in writing and it seems reasonable then it will end there. Only if there are questions that the IRS can’t seem to get answered would it escalate into an audit. The intensity of the audit is quite variable.

So, going forward. If you feel confident that you can explain this transaction so EVEN AN IRS Auditor can understand it, you have nothing but the inconvenience of an audit to fear, and even that may be unlikely.

You have a Long Term Capital Loss. Long term losses can offset long term gains dollar for dollar in the year that you realize it. Therefore, if you had $20,000 in Long term gains this year you would only be responsible to pay taxes on $5000 of gain (+$20k -$15k loss = $5k net).

If you had only $7k on gains you would offset that 7k and have 8k carry forward.

In addition the government will allow you to take $3000 of loss against ordinary income each year. In that case, if you have no gains then yes you get to deduct $3000 this year, $3000 next year, etc. until the loss is used up.

Richard Fritzler

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