I lent someone money and he put up gems that exceeded the value of the loan as collateral. He defaulted on the loan and I now have the gems. Sadly the market for gems has tanked and I will take a loss on it.
I realize I can't take the loss until I sell the gems; but when I do, how does it fit on tax return? Is it a loss on the loan? If so, does it go against ordinary income, or is something else? Or is it a capital loss, since the gems originally covered the loan but lost value?
"jack" wrote
If you're not in the business of making loans, as I suspect, the loss would be a capital loss and reported on Schedule D. The "sale" price is what you got out of it (the cash from the gem sale) and your cost basis is the amount you loaned initially.
This is an interesting situation. A few years ago, I looked this up for someone who was the victim of a Ponzi scheme and the loss on a loan is an ordinary loss less 10% of your AGI In spite of it being a collateralized loan, you still have recourse against the borrower for the difference at the time of default and you need to pursue that before you have a tax deduction.
If you take a deduction and you are audited (which is highly likely for bad debt losses on personal tax returns), even a rookie auditor is going to require the appraisal and evidence of pursuit against the borrower - specifically the borrower was successful in a bankruptcy petition or is insolvent.
The FMV of gems (especially diamonds) is significantly lower lower than the insurance value. So significant, anyone should be willing to buy gems at wholesale and use them as collateral for an 80% loan to insurance value. - Are you in the gem business? - Percentage-wise, how bad did the market tank? - Was the appraisal for insurance value or resale value?
For it to be a capital loss, you had to be holding the gems as an investment. My guess (unfortunately) is that your basis in the gems is determined as FMV on the day the loan became uncollectible. Hopefully I'm incorrect.
Dick
I poked around in TaxCut and under "help" is agrees with you; capital loss on Schedule D, but it doesn't have any means to enter it. I guess it goes in like any other investment; purchase price is what I lent; and sale price is what I sold (when I actually do that, of course) the gems for. I have been selling the gems for 5 years now and they are about half gone; can I just put in a single date and price at the end?
You never actually stated whether this was a nonrecourse loan. I.e., your only recourse to collect was the collateral if the debtor defaulted. If it was a nonrecourse nonbusiness loan, you can not take a loss (Part I of Schedule D) until the loan is worthless. This would occur when you sell off the last piece of collateral.
If this was not a nonrecourse loan, then you can not take a loss until you have actually attempted to obtain the balance due from the debtor. You must take reasonable steps to collect the outstanding balance. Once you have determined that there is no reasonable way to collect, you can write off the balance due.
Here are the instructions from PUB 550 on how to write off a nonbusiness bad debt.
On Schedule D, Part I, line 1, enter the name of the debtor and ?statement attached? in column (a). Enter the amount of the bad debt in parentheses in column (f). Use a separate line for each bad debt. For each bad debt, attach a statement to your return that contains: ? A description of the debt, including the amount, and the date it became due, ? The name of the debtor, and any business or family relationship between you and the debtor, ? The efforts you made to collect the debt, and ? Why you decided the debt was worthless.
For example, you could show that the borrower has declared bankruptcy, or that legal action to collect would probably not result in payment of any part of the debt.
It is a non-recourse loan; simply letting me have the collateral doesn't clear the debt. However I have been unable to contact them for two years despite trying, and their lawyer hasn't heard from them in longer than that; so they presumably don't exist any more. They didn't personally guaranty the loan, and the company surely has no assets.
Thanks.
That means it's a recourse loan: you have recourse to the borrower when the collateral proves insufficient.
You can look up the company with the Secretary of State of its home state, to see if it dissolved (or merely failed to make filings). It might be possible to pierce the corporate veil, if they didn't do things correctly.
Seth
See
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