USA sale of equity investment with negative basis

[kskinne]

We have an investment in a partnership that was accounted for using the equity method. There was a series of equity losses that reduced our equity basis to zero, at which point we stopped using the equity method and did not show a negative basis for the investment on our books. The operations have started to turn around, however at this point in time, we still have a negative basis in this investment, as the more recent income has not yet offset the prior cumulative losses.

We are going to sell our investment to another member for what we originally invested. The proceeds that we will receive are less than what we show for our negative basis off of the books.

Since our basis on the books is zero, will these proceeds be considered 100% gain on sale of this investment on our books? Or can we offset these proceeds against the negative basis that we had not been showing on the books while we continued to carry the investment?

Please advise - any questions let me know.

Thank you,
Kevin

 

[bklynboy]

My company had a similar situation and could not find anything in US GAAP supporting one method over another. In our case, we had $1M of unrecognized losses and sold the operation for $10M. Working with our external auditor PwC they stated that their practice has been to report the $10M as a capital gain. Logic was that we could only lose the value of our investment and not more as we never guaranteed funding future losses. As such, the unrecognized losses were not the companies to record and the proceeds should be compared solely to the carrying value of $0.

A way to think about is if you purchase a stock for $10 - the most you can lose is $10 not more. Once it goes to $0 and someone is willing to pay $5 you have a capital gain of $5. Same thing here, your loss on the investment before the sale was fully recognized in taking the balance down to $0. Its irrelevent they continued to lose more as you had no obligation to fund that loss. So when you sell it for value - the gross proceed is your gain.

Hope this is clear and helps

 

[The Finance Writer]

Although I hate the complexity of partnership accounting so much that I'm going to wish I had stayed out of this discussion, I think you have the right idea here. That is, outside basis of a partner cannot fall below zero. However, I'm hoping some accountants with experience in this matter will chime in.