Tax Treatment for A Forgiven Partnership Loan To A Partner

Question:
We borrowed $100,00 from our LLC, which is taxed as a partnership. We now have a new partner and we have forgiven the loan. How is a forgiven partnership loan treated from a tax perspective on the 1065 and 1040?

Answer:
The loan should be classified as a cash distribution as of the date of cancellation. This is consistent with IRC Section 731 and a recent private letter ruling 201314004. Please note that IRC Section 731 specifically treats payments to partners as loans if there is an obligation to repay, and a later cancellation of such loans as a distribution upon the later cancellation date. Please also note that if the amount of money deemed distributed exceeds the adjusted basis of the partner’s interest in the partnership, the partner must recognize gain on the deemed distribution under section 731(a) in the amount of the excess.

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References:
IRC Section 731; PLR 201314004

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