Paying back a loan with shares.

I let a family member borrow $40,000 in 2000 and now they wish to pay me back by transferring shares they own of a publicly traded company. I haven't charged them interest nor have i reported the loan to IRS. What is my tax liability if i was to accept the stocks? Thanks in advance. Lev

Define "family member". It makes a difference.

I lent the money to my father. Thanks.

Was there any payments made back to you? This is especially important in the first year. Also, to be considered a loan you MUST charge your father interest at current comparable interest rates. If you don't charge interest, it is a gift.

It seems to be that the IRS would view the $40000 coming from your father as a "gift" because there really was no legitimate debt to begin with. The problem lies with the fact that in order to transfer the stock and avoid reporting it as a gift, your father would have to prove that there was a legitmate debt and that he signed over the cash equivalent of stock as consideration to cancel the note. Any disparity between the stock's cash value and what was owed would be treated as a gift, or worse forgiven debt by you to your father (taxed at normal income).

Also, something you should be aware of is that your father's stock will be given to you without a step-up in basis (once again gift treatment) and you will pay any capital gains taxes (15%) on the appreciation of the stock when you sell it. Thus, $40000 of stock does not equal $40000 in cash (after taxes that is).

That's the legal mumbo-jumbo aspect of it. But if you are both cool with it, just transfer the stock into your name as a gift and have your father file an IRS Form 709 with his tax return. Everybody is happy and noone gets taxed. Remember the capital gains tax though, we don't want pops to pull a fast one on you.

Lyov,

If you do accept the stock do as Pricespector suggests.

Also get your father's basis in the stock. That will be your basis when you sell the stock for a gain.

Lyov,

If you do accept the stock do as Pricespector suggests.

Also get your father's basis in the stock. That will be your basis when you sell the stock for a gain.

Um... What is "basis"?

Thanks, Lev.

The "basis" is what is considered the "buy" point. For example, even if your father was gifted the stock by the company he worked for, the "buy" price would be its share price at the time of the gift. Let's do easy math.

Pretend Dad's stock was worth $10 when he got it. Now, it's worth $50. When he sells that stock, he owes capital gains on the profit of $40 per share.

If he transfer it to you, without out a step-up basis, it will be like YOU got the stock at $10, rather than at $50, and when you sell later (say, when it hits $100 a share), you will owe capital gains on $90 per share, not $50 per share (if you can get a Step-up basis to what it's worth today, when Dad gives it to you).

In short, it's probably a pretty lousy idea to take the stock. I'd instead ask Dad to sell the stock, pay his own capital gains taxes, and you take the cash equivalent and do what you want with it (maybe buy shares in that company, maybe take a trip around the world, whatever!). Unless you can get the stock "free and clear" (a stepped up basis, no other taxes, etc), there's no sense taking a loss on your loan to Dad.

Therefore, even though they are gifted shares, as far as the IRS sees it, Lyov would get the shares at whatever rate the father purchased the shares? Yeesh!

Puck is right, have your dad cash the shares out and pay you in cash.

I love it when it's team effort - I asked a clarifying and important question, and you guys do all the heavy lifting. Kewl!

Actually, Puck, there is no step up in basis for stock transferred from a family member. The basis will be what it is transferred at (in this case $40,000).

Lyov,


The IRS views this as an interfamily loan and here are the tax ramifications:

If your father has an investment income of over $1,000 the interest needs to be imputed just as if you were charging it at the IRS' marginal rate. If your father has less than $1,000 in interest income, then no interest needs to be imputed. The $40,000 that he transferred back to you is repayment of a loan and is NOT a gift. Also as noted, you DO NOT have to pay capital gains on his basis. Your basis will be $40,000. You are in a fine position, especially if the stock has been appreciating because if you sell the stock all the capital gains he had are completely mitigated since they were transferred to you.

Someone may want to check me on this, but I'm 99.9% sure that this is correct.

-Joe

BTW, this is a very effective family tax planning strategy. Essentially your father is avoiding possible capital gains tax.

This might be it:

http://www.irs.gov/businesses/partnerships/article/0,,id=134700,00.html#2

Puck was right in her description of the basis situation. The basis of this stock is whatever OPs father paid for the stock, since it's a family transaction.

This is not a gift, this is a repayment of a loan. Because this is a loan the father would recognize any capital gains on his tax return in the year in which he transfered the stock. For this reason, the basis for the son is the fair market value he received ($40,000), so if he sells later for $45,000 he will recognize only a $5,000 gain.

Dingo, that link has to do with partnerships.

-Joe

I'm going to go out on a limb here too, and say that IF I am wrong, I would like to see the section in the Code that proves it. :)

In order for an step-up to be applied the father would have to record a sale of the stock and pay the gains himself. This is what Puck was speaking of earlier. Trust me, capital gains taxes do not just disappear.

Yes, I didn't say that they would disappear, that was why I said, "Because this is a loan the father would recognize any capital gains on his tax return in the year in which he transfered the stock."

-Joe

Yes, this is true. But it is questionable whether a legitmate loan has occurred at all, thus the gifting treatment. A loan for $40k would generate more than $1000 of interest in a given year at current comparable rates and at least one payment must have been made annually to make the debt legitimate. The interest would have had to have been reported on the son's tax return as interest income. My take is that the loan is unprovable.

As long as the money wasn't provided for investment purposes (i.e., "loaning" money to a parent in a lower tax bracket) and was less than $100,000 it is still a loan. It is a "related persons transfer" and thus, for tax purposes, is treated differently. As long as the father's interest income for that year is less than a $1,000 (highly unlikely considering the stocks) interest does NOT need imputed on the tax returns. If his interest income is higher then it would need imputed. Also, the loan SHOULD have been documented and if it WASN'T and the father defaulted and no effort was made to recover the loan, no loss can be claimed for the son and $28,000 ($40,000-$12,000) would be taxable as a gift. However, since every thing was done in good favor (fortunately) and the loan was recovered, no documentation (legally) is necessary.

-Joe

Okay - I agree with you, Joe, the transfer is at the value of the stock (that is, if OP gets the current market value) then Father owes CG tax on the gain.

However, the following is in conflict with your more recent post:
BTW, this is a very effective family tax planning strategy. Essentially your father is avoiding possible capital gains tax.
A gain is occurring, and no exception applies (charitable contrib, death step-up), so SOMEbody will owe tax. Either at the time of the transaction or at the time of the sale of the stock.

I suspect that the transaction in question could be handled in either manner - as two offsetting gifts since no documentation occurred and no interest was charged, or a delayed purchase of the stock with the original loan proceeds. I would imagine that the former is the better option as otherwise the loan proceeds could have been in part taxable to the father in 2000.

Yes, like what he said.

To sum things up. OP can trade the stocks for the loan (which by the way, is the same as buying the stocks directly from his father with the loan principal), but keep in mind that to equal the cash equivalent: dad must give him (gift) more than $40000 of stock to offset the capital gains tax OR dad must record a sale and pay the capital gains so that the stock is given new $40000 basis.

I think this is the only thing the OP needs to be aware of. The rest just jumbles it up.

Blankenship, you are correct, when I wrote that "BTW" I was thinking of something else. Thank you for pointing that out.

Pricespector, also correct.

-Joe