Investing Through A Friend

Today TaxMama hears from Brent in the TaxQuips Forum, with an exciting opportunity. “I have been approached by a friend I trust (personally, not on the fine points of tax law) about investing in a pre-IPO stock of a foreign company that will be listed on a US exchange.  Two problems. First, I would invest through my friend, not in my own name, because there is a specific clause in the IPO that they aren’t supposed to expand the IPO through family and friends, which in my mind may be a legal issue or may just be the formal policy of the company.  Second, though I could get a receipt that I gave my friend the money in exchange for him investing it for me (is that legal?), if I were to profit (or lose money) I have no idea how to explain the transaction to the IRS.”

Dear Brent,

 If your friend has access to the stock as an employee of the company,  both the stock and HE have restrictions on the purchase. You will not own the stock, nor really have any legal standing. Your friend does not have the right to sell any of that stock or his share in the stock.  Those are specific provisions of the pre-IPO sales.

So…suppose you give your friend the money. How would that transaction be defined? As a loan?  On what terms?  When do you get paid back – and how? All the money you get in excess of the loan will be interest income. There will be no capital gains benefits. If this is the next Google – the returns could be tremendous! But there will be no tax benefits. You won’t get the special benefits for the original owner of Qualified Small Business Stock. And you and your friend might face some SEC violations issues.

Suppose you lose the money? You would have to prove your attempts to collect it. You might have to take your friend to court to prove you tried to collect it,  before you could take a bad debt deduction. Not good for his credit.

Could you make the investment as a stock purchase? I don’t see how.

Consider talking to an attorney who understands securities law to see if there is a way to write some contracts to make this work.  I don’t really see how it would work for you.  Personally, if you couldn’t get a securities attorney to write this up properly, I’d stay away from it.

And remember, you can find answers to all kinds of questions about exciting investments and other tax issues, free. Where? Where else? At www.TaxMama.com.

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