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Does it make sense for a shareholder to make a loan to an S corporation to obtain basis for taking S corporation losses?

S Corporation
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Charles Levun, J.D.
This is a topic for a one-hour seminar with many pros and cons. However, one critical item to watch out for is that repayment of S corporation debt, the basis of which has been reduced by losses, is a gain-generating transaction. (See Rev. Rul. 64-162 and regulations under §1367.) Moreover, partial repayment of a reduced-basis S corporation loan is gain-generating, even if the repayment is in an amount that is less than the then basis of the loan, because basis is applied to the repayment on a pro rata basis. If a loan to an S corporation is going to be made, it makes sense for there to be multiple loans in relatively small denominations (which are evidenced by written notes with a term of at least 10 years, also a topic for another day), because where there are multiple loans that have basis less than the current principal amount of the loan, the particular loan being repaid receives 100% of the first basis increase for profits in the year of repayment (and thereby often can avoid gain recognition).

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