Non business bad debt deduction


B

BobG

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?
 
Last edited by a moderator:
Ad

Advertisements

P

Phil Marti

BobG said:
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?
You misunderstood. The portion of the debt wiped out by the
approved plan is a deductible bad debt.
 
Last edited by a moderator:
H

Herb Smith

BobG said:
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?
Who is going to buy your worthless loan? For any amount?

How about if I donate to charity?

If the loan is worthless, that is the extent of your
"donation".
 
Last edited by a moderator:
D

dpb

BobG said:
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?
....

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.
 
Last edited by a moderator:
B

Bill Brown

BobG said:
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?
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.
 
Last edited by a moderator:
B

Bill Brown

BobG said:
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?
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.
 
Last edited by a moderator:
Ad

Advertisements

M

Mike20878

dpb said:
...

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.
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?
 
Last edited by a moderator:
S

Seth Breidbart

Mike20878 said:
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?
Yes.

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
 
Last edited by a moderator:
P

Phil Marti

Mike20878 said:
Since when is a non-business bad debt deductible?
At least since 1971. See IRS Publication 550.
 
Last edited by a moderator:
H

Herb Smith

Mike20878 said:
dpb wrote:
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?
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).
 
Last edited by a moderator:
P

Paul Thomas, CPA

Mike20878 said:
dpb wrote:
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'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.
 
Last edited by a moderator:
Ad

Advertisements

B

BobG

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:

http://www.projectposner.org/case/1996/87F3d197/

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.
 
Last edited by a moderator:
G

Gil Faver

BobG said:
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:

http://www.projectposner.org/case/1996/87F3d197/

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.
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.
 
Last edited by a moderator:
D

Drew Edmundson

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:

http://www.projectposner.org/case/1996/87F3d197/

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.
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.
 
Last edited by a moderator:
B

BobG

Gil Faver said:
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.
Unfortunately, you did read it too quickly. (Although there
was a bunch of unusual stuff going on.)

The tax issue wasn't WHICH year to claim the loss but
WHETHER they were EVER allowed to claim ANY loss given that
they had received a 23% recovery. They were denied ANY
deduction for ANY year. The bankruptcy had long since been
resolved by the time the tax issue was litigated so there
was no question that there would never be any additional
recoveries.

I'm really hoping that people can help to see if there's a
creative way to get some tax benefit from this loss rather
than continue to assert (without any proof) that it is
deductible.

According to Posner the relevant law was;

debt...was worthless on June 30, 1986, within the meaning of
the applicable provision of the Internal Revenue Code, if on
that date he had (1) no reasonable prospect, Kugel v. Ryan,
289 F.2d 329 (2d Cir. 1961); Oatman v. Commissioner, 45 Tax
Ct. Mem. Dec. (CCH) 214 (1982), of recovering (2) a
significant, though in the sense merely of nontrivial,
fraction of this amount. Rev. Rul. 71-577, supra (more than
"one or two cents on the dollar"); cf. Rodgers v.
Commissioner, 49 Tax Ct. Mem. Dec. (CCH) 1434 (1985).
Recovery of a trivial fraction of the debt would be unlikely
to cover the costs of collection, while a miraculous,
unforeseen, unforeseeable, totally unexpected recovery of
part or even the whole of a debt properly written off as
worthless years before...would be consistent with the debt's
having properly been deemed worthless in the year it was
written off. See Crown v. Commissioner, 77 T.C. 582, 598
(1981); Wolfson v. Commissioner, 45 Tax Ct. Mem. Dec. (CCH)
244 (1982).

The judgement (which restates the law) was:

Neither condition for the deduction of a nonbusiness bad
debt - a merely trivial repayment, or a miraculous repayment
- was satisfied here (a third condition, that the debt be
bona fide, we are assuming is satisfied); and so clear is
this that the government was entitled to summary judgment.
 
Last edited by a moderator:
Ad

Advertisements

S

Stuart A. Bronstein

The tax issue wasn't WHICH year to claim the loss but
WHETHER they were EVER allowed to claim ANY loss given that
they had received a 23% recovery. They were denied ANY
deduction for ANY year. The bankruptcy had long since been
resolved by the time the tax issue was litigated so there
was no question that there would never be any additional
recoveries.
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
 
Last edited by a moderator:
Ad

Advertisements


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

Similar Threads

Non-business bad debt deduction 1
Non-business bad debt 5
USA Business bad debt or non buisness bad debt 0
Business Bad Debt Deduction 11
USA Business Bad Debt 1
USA Bad Debt Expense & Cash Basis P&L 4
Bad Debt 0
Bad debt 6

Top