Unfortunately, I'm owed a substantial amount as an unsecured creditor of an entity which is currently in Chapter 11. Even more unfortunately, the loan is a "non-business" debt. It turns out that the unsecured creditors are likely to get recoveries of 5-10% of their claim amounts. My understanding is that, if the loan turns out to be completely worthless, I would be able to take a "nonbusiness bad debt deduction" and treat my loss as a capital loss. If I get even a single cent of recovery, there's no tax deduction. Does this sound right? Does anyone know of a way to ameliorate this problem?
Do I get a capital loss if I sell the loan for FMV? How about if I donate to charity?
The way I read Pub 17 and 550 on non-business bad debts, the "totally worthless" section applies only so long as there is any reasonable possibility of any repayment. Once there is a payout from the bankruptcy, my interpretation would be that the note at that time really does become totally worthless and the remaining balance can be deducted as a short-term capital loss in the tax year that occurs. That, of course, assumes that all the other provisions making it a valid loan are met.
You don't quite have the rule right. You cannot deduct a non-business bad debt until the unpaid balance on the receivable is worthless. Once you receive that 5-10% and the bankruptcy referee says that's all there is going to be, THEN you have a reportable short-term capital loss of the unpaid portion.
You don't quite have the rule right. You cannot deduct a non-business bad debt until the unpaid balance on the receivable is worthless. Once you receive that 5-10% and the bankruptcy referee says that's all there is going to be, THEN you have a reportable short-term capital loss of the unpaid portion.
Since when is a non-business bad debt deductible? If no income was reported on a prior return for the receivable - which would be the case with a non-business (i.e. personal) receivable or loan - then there is no deduction when the receivable/loan becomes uncollectable. Am I off here?
You lend a "friend" $5,000. It's a personal loan, not a business transaction. But that $5,000 was earned by you at some time, and you paid taxes on the earnings. Seth
I believe so. Your receivable is the loan note (which you should have). No income is reported because you are a cash basis taxpayer and no payments of interest were made. Once the note is deemed uncollectable, either through bankruptcy, insolvency or court order (Small Claims Court) you have a loss claim. After all, you used after-tax money to make the loan, didn't you? This is NOT the same as claiming a deduction for unpaid salary (for which you never paid tax).
You're off a little. There must be a valid debt, so no deductions for "loans" to your dependent kids that they never repaid (da bums), monies paid to, and the example in Pub 550 (I believe), a contractor who goes belly-up without doing the work or repaying the deposit can be counted as a non-business bad-debt, deductible on Schedule D as a short-term capital loss. The fact that they listed you as a creditor in their bankruptcy seals the deal as far as proving the amount and the debt as legit as well as uncollectible, Now, the year in which you took the deduction may be questionable, for say a construction loan made today and a contractor who files bankruptcy in 2007, that doesn't get cleared through the courts till 2008. I'd want to take it as early as possible, so maybe if you knew about the bankruptcy before filing the 2006 returns, take it there, else the earliest you "knew" it wouldn't be collected (or the work completed) was in 2007 when he filed on you. If in a later year he "found God" and repaid you, then report it as income.
-- Paul Thomas, CPA snipped-for-privacy@bellsouth.net
As a long time lurker in this newsgroup, I recognize that someone who is asking for free advice can't complain if no useful advice is forthcoming. I've seen some remarkable expertise on display here, so I was optimistic that someone had encountered this issue before. Non-business bad debts are common, although ones with any recovery are certainly less so. I think there are two separate issues: a) Whether I can take a deduction if I have a 90% loss rather than 100%; and b) if there is any way to mitigate the impact if the answer to a) is no.
CAN I DEDUCT A PARTIAL LOSS:
Several people commented that I *could* take a deduction for the remaining portion of my debt once the bankruptcy was concluded and it was clear that no further recoveries were forthcoming. This was also my original impression. Unfortunately, I have it on good authority that the IRS apparently takes a hard line that for a *non-business* bad debt only a 100% loss qualifies for any deduction. I also googled this and came up with this case with that holding:
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I don't like this answer, so I'd be happy with a different one. Unfortunately, the guesses of newsgroup particants aren't good authority. Unless someone comes up with a cite to a case that supports the deduction please just assume that the rule is as I stated. IS THERE A WAY TO CREATE A DEDUCTION?:
If the rule is as I stated, is there action that I can take to generate a tax benefit? One thought was to sell the claim for cash. That would give me a capital loss. Unfortunately, since the original loan was not for investment purposes, the capital loss might not be deductible at all. Any thoughts? So far, the only response to that idea was some obviously didn't bother to read my post since he asked: "Who is going to buy your worthless loan? For any amount? " As I said in the OP, the whole issue is that the loan
*isn't* worthless. If it were, I wouldn't be posting here. I've subsequently researched the charitable donation idea and it doesn't work since the donation is limited to FMV. A new idea is to contribute the asset to a corporation I control in return for stock. Although I wouldn't get an immediate deduction, if my basis in the stock were my old basis in the loan rather than FMV, that would be a benefit. Any thoughts? Moderator: I do not recall any prior posts on this. You may want to restate the actual situation. I will buy your bad debt for a nickel cash, but I won't come to court for you unless my expemses are piad up front. ALSO Buchanan v. US is a very convoluted set of facts and circumstances.
I read that case pretty quickly, but I think it is not saying that you cannot have a deduction unless you loose the entire amount of your loan. I think it simply says that the taxpayers in that case were trying to take the deduction before it was fair to say that the remaining amount of the loan no longer had any possibility of recovery. In other words, if you get some recovery from the bankruptcy court, and then it is clear the remaining amount is nonrecoverable, that is the amount you may claim as a tax loss, and that is the year in which you can claim the tax loss. The Buchanans claimed a tax loss in 1986, and yet in subsequent years received some payment on the loan.
You are misunderstanding the rule. It is true that a nonbusiness bad debt cannot be deducted until it is wholly worthless - see Code Section 166. But wholly worthless does not mean you can't have received any payments. It means the remaining balance is wholly worthless. BNA cites to these cases - Pierson v. Comr., 27 T.C. 330 (1956); Feltex Corp. v. Comr., T.C. Memo (Apr. 9, 1953); Smith v. Comr., T.C. Memo (Feb. 12, 1953); Faegeol v. Comr., T.C. Memo 1961-178. I have not read them so YMMV. For certain business bad debts the part that is worthless can be written off and the collectible balance is not. This is a partially worthless debt.
The statute and regulations only talk of a debt which becomes wholly worthless in any year. To me that means that it didn't have to be wholly and completely worthless - just the balance that was due in the year it became worthless. So I'd interpret that to mean that yes, you can take the loss on a non-business bad debt in the year the balance becomes worthless, in the amount that it becomes worthless. I did a quick review of cases but didn't find much. But here's one case that is an indication that the IRS takes the position I have determined to be correct. Stahl v. United States, 441 F.2d 999 (D.C. Cir. 1970). In that case the taxpayer either invested in or lent (the structure of the transaction makes it unclear which it was) money to a securities firm that subsequently went bankrupt. The total loss was $127,000 but in the bankruptcy she expected a distribution of about $40,000. The issue was whether it was a business or non-business bad debt. The court observed, "The taxpayer and the Government agree that the loss is deductible in some manner at some point in time; the dispute is over the proper characterization of the loss and hence its proper tax treatment." So even though the debt wasn't 100% worthless, a portion of the debt became completely worthless. And the IRS agreed she was entitled to a deduction of the worthless amount. Stu
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