Taxpayer's Guarantees on Loans to Related Businesses Entitled Him to Deduct Losses

(Parker Tax Publishing February 2020)

The Tax Court held that a taxpayer's personal guarantee of a loan to a business that he wholly owned established sufficient amounts at risk under Code Sec. 465 to entitle him to deduct the losses related to that business. The court further concluded that the taxpayer's personal guarantee of a second loan to a partnership, of which he was a 90 percent partner, increased his basis in the partnership under Code Sec. 704(d) and established amounts at risk under Code Sec. 465 sufficient to entitle him to deduct his share of suspended losses that had been disallowed in a prior year. Bordelon v. Comm'r, T.C. Memo. 2020-16.

From 2008 - 2011, Rock Bordelon was in the healthcare business and the income from this business was the primary source of income for Bordelon and his wife, Torie. During these years, Bordelon owned Allegiance Health Management, Inc. (AHM), which provided hospital management services, and Many LLC, which he formed to purchase and own a hospital in Many, Louisiana. To make that purchase, he received a USDA development loan (the Many Loan) from Union Bank and listed Many LLC and AHM as the borrowers. Bordelon executed a note on the borrowers' behalf, listed the hospital and its equipment as collateral, and executed a personal guarantee, as required by the USDA, for the Many Loan.

For federal tax purposes, Many LLC was a disregarded entity, and Bordelon reported its income and expenses on Schedule C, Profit or Loss From Business. For 2008 and 2009, Bordelon and his wife reported net losses and claimed deductions attributable to Many LLC. For 2010 and 2011, Bordelon reported net profits attributable to Many LLC.

Bordelon also owned a 90 percent interest in Kilgore LLC, which owned and operated a hospital in Texas. Kilgore LLC had substantial losses in 2008, about $14,000 of income allocable to Bordelon in 2009, and $0 of income in each of 2010 and 2011. In 2011, Kilgore LLC obtained a loan (the Kilgore Loan) from Home Federal Bank (HFB), which required Bordelon's personal guarantee. Bordelon was the sole guarantor and the only member of Kilgore LLC bearing personal liability for the Kilgore Loan. The guarantee of the Kilgore Loan was an absolute and unconditional guarantee of performance under the loan, entitling HFB to enforce its rights against Bordelon without proceeding against any other obligor on the underlying debt. Kilgore LLC was treated as a partnership for federal tax purposes and reported its income and expenses on Form 1065, U.S. Return of Partnership Income. For 2008, Bordelon claimed deductions for his share of Kilgore LLC's losses as reported on Schedule E, Supplemental Income and Loss, of his return for 2008.

The IRS issued notices of deficiency for 2008 - 2011 and determined that: (1) for 2008, Bordelon failed to establish amounts that he had amounts "at risk" under Code Sec. 465 which entitled him to deduct losses related to Many LLC, and (2) under Code Sec. 704(d), Bordelon had an insufficient basis in Kilgore LLC to deduct related losses for 2008, and he failed to establish amounts at risk under Code Sec. 465 that would entitle him to deduct losses related to Kilgore LLC. The Bordelons conceded the 2008 disallowance as to Kilgore LLC but argued that: (1) Bordelon's personal guarantee of the Many Loan satisfied Code Sec. 465 and allowed him to deduct losses related to Many LLC for 2008, and (2) Bordelon's personal guarantee of the Kilgore Loan increased his basis in Kilgore LLC enough to allow him to deduct for 2011 the suspended losses disallowed for 2008.

The Tax Court held that Bordelon's personal guarantee of the Many Loan established sufficient amounts at risk under Code Sec. 465 to entitle him to deduct the losses related to Many LLC for 2008. The court further concluded that Bordelon's personal guarantee of the Kilgore Loan increased his basis in Kilgore LLC under Code Sec. 704(d) and established amounts at risk under Code Sec. 465 sufficient to entitle him to deduct for 2011 his share of suspended losses disallowed for 2008.

The court noted that Bordelon executed a personal guarantee in 2008 for the Many Loan. Under that guarantee, the court said, Bordelon became directly liable to Union Bank for the full amount of the debt if the obligors defaulted. There was no other guarantor on the debt, nor was there a definite or fixed right to any contribution from other members of Many LLC or from AHM on account of the debt. Indeed, the court stated, Bordelon was the sole owner of these entities and the only person with unlimited liability for the Many Loan. According to the court, even if it disregarded a worthlessness determination when considering Bordelon's realistic possibility of economic loss, it could not disregard that, in substance, Bordelon was the only one involved with respect to the liability for the Many Loan, the corresponding promissory note, and the personal guarantee. Accordingly, the court was persuaded that Bordelon was personally liable, not protected against loss, and ultimately at risk under the Many Loan during 2008 so as to be entitled to deduct the losses related to Many LLC that he claimed on the couple's 2008 return.

With respect to the question of whether Bordelon had sufficient basis in Kilgore LLC for 2011, the court cited Reg. Sec. 1.752-2(b) through Reg. Sec. 1.752-2(k) which provide a "constructive liquidation" test for determining whether a liability is recourse to a partner. Under that test, the following events are deemed to occur simultaneously: all partnership liabilities become payable in full; all assets (except property contributed to secure a partnership liability) become worthless; the partnership disposes of all of its property in a fully taxable transaction for no consideration (other than satisfaction of nonrecourse liabilities secured by the property); the partnership allocates all items of income, gain, loss, or deduction for its last tax year as of the date of the constructive liquidation; and the partnership liquidates. If a partner would be liable for a debt under those circumstances, then the liability is deemed recourse to that extent.

Applying the "constructive liquidation" test to the facts of the case, the court said it could not perceive any scenario in which Bordelon could not be considered economically at risk for the HFB debt to the full extent of his guarantee. There were no other partnership assets securing any of the debt; no other partner was liable for any portion of the debt; and if the debt were due in full, HFB would certainly have sought payment directly from Bordelon. Thus, it was persuaded that when Bordelon guaranteed the loan in 2011, it became a recourse obligation that increased his basis in Kilgore LLC and allowed him to deduct the same amount in Kilgore LLC losses carried forward from 2008. This analysis also enabled the court to conclude that Bordelon's guarantee of the Kilgore Loan increased his amount at risk in Kilgore LLC for 2011.

Observation: The court did say that there might be a scenario in which a partner's basis could increase on account of a guarantee but in which the guarantee would not result in his being considered at risk under Code Sec. 465, but noted this was not such a case.

For a discussion of determining amounts at risk under Code Sec. 465, see Parker Tax ¶247,520.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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