Reducing Your S corporation's Tax Basis in the Correct Order

Losses reduce your tax basis in the following order for S corporations:

  • Stock basis: First, reduce your stock basis (but not below zero).
  • Loan basis: Next, if the loss exceeds your stock basis, you reduce your loan basis by the excess amount (but not below zero).
  • If any loss still remains, it is not deductible in the year it was created. It is called a suspended loss. A suspended loss may be carried over to future years indefinitely, until you have sufficient tax basis to cover it. You may cover a suspended loss by restoring your tax basis.

Restoring Your Tax Basis In the Correct Order

To restore your tax basis, you do so in the following order:

  • First, restore your loan basis to its original amount
  • Next, restore your Stock basis

Example:

Tax basis adjustments:

Your tax basis at the end of 2012 is $8,000, and is comprised of the following:

  • Your stock basis of $5,000.
  • Your loan basis of $3,000.

Here's the situation at the end of 2012:

  • The S corporation had a $10,000 in loss.
  • You actively participated in the business.

Here's what you must do:

  • First, reduce your stock basis first by $5,000 to a zero basis.
  • Next, reduce your loan basis by $3,000 to a zero basis.
  • This brings your tax basis at the end of 2012 to zero.
  • You then carry the $2,000 suspended loss over to the following year.

To restore your tax basis in a subsequent year so that you may claim the $2,000 suspended loss, you must do so in the following order:

  • First, increase your loan basis by $2,000.
  • Next, increase your stock basis (if you can).

By restoring your loan basis by $2,000, which is equal to the suspended loss, you will be able to deduct the $2,000 loss in 2013.

Lesson learned - cover your loss!

If you expect to incur a loss but won't have enough basis to deduct the full amount of the loss, increase your basis by either lending or investing enough money to the corporation to bring your basis up to the amount of the loss.

In the above example, had you added $2,000 to your $8,000 tax basis by either increasing your stock basis or loan basis before the end of 2012, you would have had sufficient basis to cover the $10,000 loss, and therefore, could have deducted the entire $10,000 in 2012 instead of having to carry over $2,000 to the following year.


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