Discussion:COD from Related Party Installment Note

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.

After reviewing Section 108, I've come to the following conclusions (correct me where I stray):

You can do a Purchase money debt reduction in the event the buyer (in my case an S-Corp) of the land on installment is solvent. If the buyer is insolvent (as is the case in my client's situation)then a reduction isn't necessary anyway, as the COD income will be excluded from gross income to the extent the client is insolvent.

I assume if the COD income exceeds the amount of insolvency, a purchase money debt reduction can be done to the extent of the solvency of the S Corp, right?

I also assume for the seller, in either case (purchase money debt reduction or discharge of indebtedness), the seller debits the remaining deferred gain, and credits the note receivable.

For the buyer, under a Purchase Money Debt Reduction, (i.e. the buyer is solvent), the note payable is reduced and the land (in this case inventory) is reduced, but under discharge of indebtedness (i.e. the seller is insolvent), the credit is "COD income", which is excluded from gross income via Form 982 to the extent of insolvency of the S-Corp.

Do those look like the correct entries? TIA.