THE SITUATION

As the economy in Costa Rica softened, an established RCCB client decided it was time to sell his position in a Costa Rican business in order to stem losses and free up capital for use in other initiatives. A buyer was ready to move quickly. Unfortunately, the client was in a complicated business partnership that made it preferable to avoid immediately distributing the proceeds of the sale. 

Complicating matters, the Costa Rican business was organized as a Sociedad Anonima, or “S.A.”. Ordinarily, U.S. taxpayers can elect to treat most foreign entities as either pass-through entities or as separately taxed corporate entities. However, a Costa Rican S.A. is always treated as a foreign corporation for U.S. tax purposes. This meant the S.A.’s capital loss would be reported as a loss to the S.A., not as a pass-through loss. As a result, without distributing the proceeds of the sale, the client could not deduct the loss to reduce his U.S. tax liability.

The Approach

In order to help the client take full advantage of the associated tax relief on the losses, RCCB’s tax team advised that the Costa Rican company could be converted into a Sociedad de Responsabilidad Limitada, or S.R.L.   This restructuring would allow RCCB’s client to file an IRS “check the box” election to treat the S.R.L. as a pass-through entity for U.S. tax purposes. 

THE OUTCOME

As a result of the restructuring, the sale went through and U.S. tax law treated the client as if he had received the depreciated assets of the S.R.L. in exchange for stock in the former S.A., capturing the client’s loss for U.S. tax purposes.  As a result, the client was able to reduce his U.S. tax liability by hundreds of thousands of dollars.