Lost Collateral on Secured Loan


G

ga_dude

My son-in-law was part of an LLC (Bad Latitude) that took out a $200K
loan to finance a restaurant. I pledged a money market of mine with
$200K as collateral for the loan. The restaurant has now gone out of
business and the unpaid balance on their loan is approx. $166K. The
bank intends collect on the loan from the collateral account. It is
doubtful that any additional money from the partners of Bad Latitude
will be forthcoming.

What are my tax reporting options concerning the lost of $166K.
 
Ad

Advertisements

J

jhhtexas

My son-in-law was part of an LLC (Bad Latitude) that took out a $200K
loan to finance a restaurant.  I pledged a money market of mine with
$200K as collateral for the loan.  The restaurant has now gone out of
business and the unpaid balance on their loan is approx. $166K.  The
bank intends collect on the loan from the collateral account.  It is
doubtful that any additional money from the partners of Bad Latitude
will be forthcoming.

What are my tax reporting options concerning the lost of $166K.
You seem to meet all the qualifications for a non-business bad debt:
1. You have a legal obligation to pay the debt
2. The assets are worthless
3..Debt arose from amounts actually loaned from your income previously
taxed.

Take the $166 bad debt as a deduction the year the creditor collects.


Jim Hammond, EA
 
R

removeps-groups

 You seem to meet all the qualifications for a non-business bad debt:
1. You have a legal obligation to pay the debt
2. The assets are worthless
3..Debt arose from amounts actually loaned from your income previously
taxed.
Another qualification of non-business bad debt is that it must not
arise in connection with your trade or business.

It looks like a business is involved here. Non business bad debt does
not make sense to me. Looks like investing capital, and losing your
investment. Non business bad debt is deductible on Schedule D as a
short term loss, but an investment loss is deductible as a short or
long term loss on Schedule D.
 
G

ga_dude

Another qualification of non-business bad debt is that it must not
arise in connection with your trade or business.

It looks like a business is involved here.  Non business bad debt does
not make sense to me.  Looks like investing capital, and losing your
investment.  Non business bad debt is deductible on Schedule D as a
short term loss, but an investment loss is deductible as a short or
long term loss on Schedule D.
While the money was put up as collateral to facilitate a business loan
- that is now in default - it is not my business to be making loans.
As a practical matter, especially since I will have neither $166K in
short term nor long term losses this tax year (2011), the net
difference seems to matter little.
 
D

D. Stussy

ga_dude said:
While the money was put up as collateral to facilitate a business loan
- that is now in default - it is not my business to be making loans.
As a practical matter, especially since I will have neither $166K in
short term nor long term losses this tax year (2011), the net
difference seems to matter little.
I agree that this is a NON-business bad debt because it was not a business
operated by the taxpayer who has lost his investment.
 
R

removeps-groups

But you're an investor. I don't see this as being different from
buying stocks/bonds and selling it for a loss.

It matter because if it's a long term loss then the carryover is a
long term carryover. It will be balanced against long term gains
first.
I agree that this is a NON-business bad debt because it was not a business
operated by the taxpayer who has lost his investment.
There are 3 possibilities:

- Either the original person made an investment.
- Or the person gave money to his son who then made an investment, in
which gift tax considerations are involved
 
Ad

Advertisements

G

ga_dude

But you're an investor.  I don't see this as being different from
buying stocks/bonds and selling it for a loss.


It matter because if it's a long term loss then the carryover is a
long term carryover.  It will be balanced against long term gains
first.


There are 3 possibilities:

- Either the original person made an investment.
- Or the person gave money to his son who then made an investment, in
which gift tax considerations are involved
Just to clarify on this last point. I put money as collateral for a
loan made by a bank to Bad Latitude - an LLC - which my son-in-law was
one of three partners. Bad Latitude used the proceeds of the loan to
open a restaurant - which was in business for almost 3 years before it
went out of business. Bad Latitude had paid down the loan to the bank
somewhat, but after going out of business, have defaulted on the
remaining balance of the loan.
 
P

Pico Rico

Just to clarify on this last point. I put money as collateral for a
loan made by a bank to Bad Latitude - an LLC - which my son-in-law was
one of three partners. Bad Latitude used the proceeds of the loan to
open a restaurant - which was in business for almost 3 years before it
went out of business. Bad Latitude had paid down the loan to the bank
somewhat, but after going out of business, have defaulted on the
remaining balance of the loan.

I have to wonder if you were to obtain any benefit from providing the
collateral. Any interest to be paid to you? A share of the profits? A
share of the business? Or was this just to help your son? Who were the
other investors in the LLC?
 
G

Gene E. Utterback, EA, RFC, ABA

snipped a LOT
Just to clarify on this last point. I put money as collateral for a
loan made by a bank to Bad Latitude - an LLC - which my son-in-law was
one of three partners. Bad Latitude used the proceeds of the loan to
open a restaurant - which was in business for almost 3 years before it
went out of business. Bad Latitude had paid down the loan to the bank
somewhat, but after going out of business, have defaulted on the
remaining balance of the loan.
I've been following this post but hadn't yet responded due to time
constraints. I'm still under those constraints but I see this moving in
what I consider the wrong direction so I want to jump in.

The OP put up collateral for a loan. The borrower defaulted, the collateral
was forfeit. The person who put up the collateral was not involved in the
business and wants to know what recourse they have.

I'm not sure you have any recourse at all, likely not even a tax deduction.
To get a tax deduction you have to have engaged in some sort of taxable type
of transaction.

Did you loan money to the LLC, NO! If you had you'd have a note, which the
IRS would expect you to attempt to enforce before you took a deduction.

Did you buy an interest in the LLC, NO! If you had, you'd be listed on the
returns as an owner and you'd get a K-1. You'd also be able to write off
your investment in the LLC as worthless.

Did you loan your son money? Probably not, at least not from what I read.
If you had you would still be expected to attempt collection. Whether you'd
want to pursue legal actions against your son or not I can't say.

The question I need to ask you is this - do you have ANY documents in place
with anyone about you putting up the collateral OR did you simply do it as a
favor to your son?

What may be worse yet is that it is possible that you losing the collateral
to the bank COULD result in a deemed gift to your son. You may have a gift
tax return due as a result of what you did.

This is why its important to work with a professional BEFORE you do
something. We may not like what you want to do and may advise against it,
but most of us can find a way to help protect your interest in the event
things go south. What we can't do is fix somethings after the fact,
especially once the year for the activity has closed.

Sorry,
Gene E. Utterback, EA, RFC, ABA
 
P

Pico Rico

Gene E. Utterback said:
snipped a LOT


I've been following this post but hadn't yet responded due to time
constraints. I'm still under those constraints but I see this moving in
what I consider the wrong direction so I want to jump in.

The OP put up collateral for a loan. The borrower defaulted, the
collateral was forfeit. The person who put up the collateral was not
involved in the business and wants to know what recourse they have.

I'm not sure you have any recourse at all, likely not even a tax
deduction. To get a tax deduction you have to have engaged in some sort of
taxable type of transaction.

Did you loan money to the LLC, NO! If you had you'd have a note, which
the IRS would expect you to attempt to enforce before you took a
deduction.

Did you buy an interest in the LLC, NO! If you had, you'd be listed on
the returns as an owner and you'd get a K-1. You'd also be able to write
off your investment in the LLC as worthless.

Did you loan your son money? Probably not, at least not from what I read.
If you had you would still be expected to attempt collection. Whether
you'd want to pursue legal actions against your son or not I can't say.

The question I need to ask you is this - do you have ANY documents in
place with anyone about you putting up the collateral OR did you simply do
it as a favor to your son?

What may be worse yet is that it is possible that you losing the
collateral to the bank COULD result in a deemed gift to your son. You may
have a gift tax return due as a result of what you did.

This is why its important to work with a professional BEFORE you do
something. We may not like what you want to do and may advise against it,
but most of us can find a way to help protect your interest in the event
things go south. What we can't do is fix somethings after the fact,
especially once the year for the activity has closed.

Sorry,
Gene E. Utterback, EA, RFC, ABA

your points are very good, but I would add that maybe (what do those
documents say?) the loss of the collateral CREATES a loan to the LLC, which
efforts can be made to have repaid. Lots of luck on that, but at least this
scenario creates a loan to be written off.
 
G

Gene E. Utterback, EA, RFC, ABA

Pico Rico said:
your points are very good, but I would add that maybe (what do those
documents say?) the loss of the collateral CREATES a loan to the LLC,
which efforts can be made to have repaid. Lots of luck on that, but at
least this scenario creates a loan to be written off.
With all due respect to my esteemed colleague, Pico Rico, and with the
caveat that if you ask 100 enlightened and educated professionals a question
you can easily get 101 legitimate responses -

I DISAGREE - I do not see the loss of collateral as creating a loan to the
LLC. Additionally, even if it did, there is no way to attempt collection
from an already defunct entity. And with the related party issues
documentation is very important in supporting any position taken that
results in a tax benefit and nothing I've seen indicates that there is any
documentation of any sort.

In my never humble opinion (yes, I spelled it out for impact) I think this
created a gift to the son and a gift return is due.

Gene E. Utterback, EA, RFC, ABA
 
Ad

Advertisements

S

Seth

I DISAGREE - I do not see the loss of collateral as creating a loan to the
LLC.
Suppose the LLC had merely decided not to pay, and the bank collected
the collateral. Wouldn't the guarantor then be able to collect from
the LLC? These events might not have created a loan, but they do seem
to have created a debt.
Additionally, even if it did, there is no way to attempt collection
from an already defunct entity.
That just makes the debt uncollectible.
And with the related party issues
documentation is very important in supporting any position taken that
results in a tax benefit and nothing I've seen indicates that there is any
documentation of any sort.
There has to be some else the lender couldn't have collected the
collateral.

Seth
 
D

D. Stussy

Pico Rico said:
your points are very good, but I would add that maybe (what do those
documents say?) the loss of the collateral CREATES a loan to the LLC, which
efforts can be made to have repaid. Lots of luck on that, but at least this
scenario creates a loan to be written off.
The loss of collateral could also create a GIFT to the LLC if the owner of
the collateral has no recourse against the LLC for recovery.

Don't make assumptions. If you want a correct answer, give us ALL the
facts.
 
P

Pico Rico

Gene E. Utterback said:
With all due respect to my esteemed colleague, Pico Rico, and with the
caveat that if you ask 100 enlightened and educated professionals a
question you can easily get 101 legitimate responses -

I DISAGREE - I do not see the loss of collateral as creating a loan to the
LLC.
ok, we disagree.

Additionally, even if it did, there is no way to attempt collection
from an already defunct entity.
yes, we agree. That would have no bearing on whether this is the creation
of a loan.

And with the related party issues
documentation is very important in supporting any position taken that
results in a tax benefit and nothing I've seen indicates that there is any
documentation of any sort.

In my never humble opinion (yes, I spelled it out for impact) I think this
created a gift to the son and a gift return is due.
That may very well be, as I indicated when I said "what do those documents
day?".

However, I think it is worth considering if in this case the loss of
collateral creates a loan. I would imagine that in a normal situation that
would be the case. For example where there is proper documentation and the
person providing the collateral participated in the business or its
ownership. I think there were a lot of good "issue spotting" responses,
including yours. How these spotted issues play out in this particular
situation depends on the facts, of which we have relatively few.
 
Ad

Advertisements

G

Gene E. Utterback, EA, RFC, ABA

Pico Rico said:
SNIPPED

For example where there is proper documentation and the person providing
the collateral participated in the business or its ownership. I think
there were a lot of good "issue spotting" responses, including yours. How
these spotted issues play out in this particular situation depends on the
facts, of which we have relatively few.
And this is the crux of my position - documentation. No documentation
between the person who put up the collateral and ANYONE else, not the son,
not the LLC, not the bank, not anyone as near as I could tell from the OP.

And you have hit the nail on the head with your last sentence - we have
relatively few facts on which to make an educated guess.

One of the things that I have always liked about this NG, and NGs like this
in general, is that they are a GREAT place to get help making sure you
haven't overlooked something, what some might call "thinking outside the
box." But the biggest fear I have for those who come here is that the
information they get from the responders (you and me and the others) is a
suitable substitute for professional assistance, and it isn't - not even
from me a licensed tax professional with almost 30-years experience.

The purpose of my post was to point out to the OP that not only might he not
get the treatment he was looking for, a tax deduction, but he might be in
for a little "salt in his wound" by having his collateral considered a gift,
especially in the absence of any documentation and most especially when he
engaged in a related party transaction.

As much as I'd like to HOPE he can call it an undocumented loan and get some
preferential tax treatment, I would be remiss if I failed to point out to
him that he may be in a much less favorable position than he had originally
considered.

Gene E. Utterback, EA, RFC, ABA
 

Ask a Question

Want to reply to this thread or ask your own question?

You'll need to choose a username for the site, which only take a couple of moments. After that, you can post your question and our members will help you out.

Ask a Question

Top