1 Research Module #3 Scenario. Roger and Peggy are husband


Research Module #3


Roger and Peggy are husband and wife and resided in Wheat Ridge, Colorado. Roger is and has been employed full-time as an airline pilot for United Airlines for approximately twenty-eight years. Pursuant to regulations of the Federal Aviation Administration, he must retire upon reaching his 60th birthday, which will occur in February of 2020.

The issue in this case arises out of Roger’s investment in a restaurant in Aspen, Colorado, known as “Dan Guarani’s Fiesta Roma Ristoranti.” The restaurant was owned by a corporation named “Dan Guarani’s, Inc. (hereinafter referred to as “DGI”). Because of its location, the restaurant’s business was seasonal in nature and primarily served skiers who visited the popular recreational area during the winter months. DGI was incorporated under the laws of the State of Colorado on October 24, 2012. At the time of incorporation, the president and sole shareholder was Robert Ryder. The original articles of incorporation did not include a plan for the issuance of Section 1244 stock.

Roger became involved in the business in or around 2014, in hopes of developing a supplementary retirement income through the restaurant. Initially, his involvement consisted of advancing money and visiting the restaurant once or twice a month in order to review the books and records and to check generally on the operations of the business.

During 2014 and 2015, Roger made a number of cash advances to DGI and/or to Robert Ryder personally for use in operating the restaurant. The dates of the advances, amounts and interest rates are set forth below:



Interest Rate

Jan 26, 2014



June 4, 2014



Nov. 9, 2014


None stated

Dec. 29, 2014


None stated

Dec. 29, 2014



Dec. 9, 2015


None stated


Total Principal

Amount of Advances

All advances except the last one were evidenced by promissory notes of DGI. The first three notes were also co-signed by Robert Ryder. The last advance was a direct payment by Roger to the IRS for employment taxes owed by DGI.


On December 9, 2015, an agreement was entered into by Roger, DGI, and Robert Ryder in order to settle litigation which was then pending between them (the exact nature of which is not reflected in the record). As part of this agreement, all prior advances made by Roger to DGI and/or Robert Ryder were consolidated and a new promissory note was executed. The total of the advances made by petitioner to DGI and/or Robert Ryder as of the date of the agreement was $71,714.90. Including accrued interest, the parties agreed upon a total liability of $80,821.87. A new promissory note was executed for this amount, bearing an interest rate of 9.50% and specifying that it was payable 30 days from December 9, 2015. The new note was signed by DGI and Robert Ryder personally. The capital stock of DGI was pledged as security for the note.

DGI and Robert Ryder defaulted on the new note and Roger, acting pursuant to the terms of the security agreement under Colorado law, foreclosed and became the owner of all DGI stock on or about February 11, 2016. Initially, Mr. Ryder contested the legality of petitioner’s foreclosure action in court. However, on March 12, 2016, a settlement agreement of the foreclosure action was reached. The primary provisions of that agreement were that Ryder agreed not to contest Roger’s foreclosure action by which Roger received ownership of all DGI stock, and Roger agreed to make all reasonable efforts to sell the stock to a third party by placing it on the market within one year from the date of the agreement. The “prime consideration” was stated to be that of selling a viable business entity, and to that end Roger was allowed to operate the business as he saw fit prior to the contemplated sale.

The agreement also provided for the division of the ultimate sales proceeds if and when the business was sold. First, outside creditors were to be paid. Then, Roger was to be paid the amount owed to him as a result of the note dated December 9, 2015. Finally, any remaining proceeds were to be divided 80% to Roger and 20% to Ryder. The same agreement also provided that “at the time of execution of this agreement, Ryder shall be released from any obligations he has under the note dated December 9, 2015, given by Ryder and the Corporation to Roger.” There was no comparable provision releasing the corporation from liability.

On February 13, 2016, a special meeting of the Board of Directors of DGI was held. At this meeting, a plan was adopted to issue stock pursuant to Section 1244 of the Internal Revenue Code as amended. On the same date, DGI issued 3,750 new shares of stock to Roger.

Roger, as the sole shareholder, managed the restaurant himself for over a year, i.e., from February, 2016 to April, 2017. He was evidently fairly successful, with the corporation grossing some $180,000 to $200,000 per year and reducing the outstanding debt by some $23,000, during which time Roger advanced $13,000 of his own money. The corporation therefore made an economic “profit” of approximately $10,000 during this period, and Roger felt that he had turned the business around.

The restaurant was listed with a real estate broker on January 30, 2017 at a stated price of $172,500.00. An offer of $75,000 was received and a contract for purchase and sale of the assets


of the restaurant was drawn up on or about April 16, 2017. The validity of the contract was made contingent upon the successful renegotiation of the lease by the purchaser with the landlord. The purchaser was unable to renegotiate the lease and therefore nullified the contract.

Although the time frame is unclear, the landlord subsequently served notice of eviction and evicted DGI. A lawsuit was filed by DGI against the landlord. However, the landlord filed a bankruptcy petition in Federal court that is apparently still pending. Due to the fact that Roger’s claim against the landlord is an unsecured claim and to the presence of many secured claims, the likelihood of any recovery in that lawsuit is minimal.

The actual deduction claimed on Roger’s Federal income tax return was $71,715. However, the parties have stipulated that $12,823 of this amount will be allowed as an ordinary loss, pursuant to section 1244 of the Internal Revenue Code as amended. This represents the portion of Roger’s stock that was issued pursuant to a plan under that Code section following Roger’s acquisition of the stock involved in this case. In a statutory notice, the IRS determined a deficiency of $9,438.00 in Rogers’ 2018 Federal income tax liability. Following concessions by Roger and Peggy, the only issue is the allowability of a $58,892.00 deduction which Roger and Peggy claimed as a business bad debt. The IRS does not contest that Roger’s investment/loans became worthless in 2018.

Instruction: Provide your advices to Roger and Peggy.

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