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Issues regarding gain or loss upon the sale of stock are common issues faced by a Denver tax attorney or business attorney at The McGuire Law Firm.  ADenver Small Business Attorney recent United States Tax Court case dealt with gain recognition when a taxpayer was relieved of debt through court proceedings.  The Tax Court agreed with the IRS that the taxpayer’s basis needed to be reduced to reflect a court ordered debt reduction.

The applicable taxpayer had entered into an option to purchase stock within an S corporation and then agreed to purchase the shares of stock from another shareholder for approximately $5.8 million.  The taxpayer purchasing the shares eventually filed suit to seeking to rescind the contract due to a mistake in the value of the stock to be purchased.  The court held that the fair market value of the shares of stock to be purchased through the agreement was actually $1 million.

Upon sale of the stock for $3 million, the taxpayer claimed a capital loss on his Schedule D when reporting the gain or loss from the sale of the stock.  The Internal Revenue Service audited the taxpayer’s Individual Income Tax Return and argued that the basis in the stock should be the judgment amount of $1 million from the prior court proceedings.   The gain or loss on the sale or other disposition of property is the difference between the amount realized and the properties adjusted basis.  Basis is generally the cost of the property, and in the case of S corporation stock, basis can be adjusted as required under IRC Section 1367.  Thus, the IRS issued a notice of deficiency to the taxpayer claiming the that taxpayer actually had a capital gain of $2 million as opposed to a capital loss.

The court agreed with the Internal Revenue Service given the fact the taxpayer was only obligated to pay the $1 million, and found that the $1 million purchase price for the shares was the true economic reality of the transaction.  Thus, the correct reporting of the transaction would be that of capital gain and not a capital loss.

If you are considering purchasing an interest in a business it is important to understand the impact your basis will have regarding the gain or loss on any sale or disposition, and how your basis can be adjusted per the Internal Revenue Code.  A Denver tax attorney or business attorney at The McGuire Law Firm can assist you with the tax implication of business transactions in addition to other business matters.

This article has been prepared by John McGuire.  John is a business attorney and tax attorney working with individuals and businesses.  Schedule a free consultation with a Denver business attorney by contacting The McGuire Law Firm.


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