Tenant Loan- Bad Debt

[Sabre]

Client of mine has a large commercial building-he is an architect- he loaned one of his tenants money to buy equipment for the tenant's business in the building. The tenant filed for bankruptcy the equipment is long gone. Loan in writing and well documented

The rental is reported on a schedule E. Everything seems to point to a business bad debt which mentions deducting business loan on a schedule C.

Where should I take this loss- schedule E or schedule C ?

[ATSMAN]

Unless the architect is also in the business of lending money to his tenants in the ordinary course of his business I would put the un-collectable debt on sch D. Subject to the annual limit of deducting investment losses!

[Bob McCoy]

I would also say non business bad debt. There doesn't appear to be a business relationship between the two parties, other than one person paying rent to another. That in and of itself doesn't seem to fit the definition doing business as a business. At least none that I have run across.

[Roland Slugg]

You referred to Schedule C, so I infer from that that the architect's business is not a corporation. If it is a corporation, and the corporation made the loan, then it's definitely a business bad debt.

Did the architect make the loan with funds drawn on the architect's business account, the commercial building's rental account, or from his personal account (assuming he has separate accounts)? If the business or rental account, that would help demonstrate that it was a business loan. A taxpayer does not have to be in the "business" of loaning money in order for a loan to be treated as a business loan. There only has to be a proximate relationship, and a bad debt is proximately related to business if business is the dominant motivation for the debt.

Based on the facts in your post I would be strongly inclined to treat this as a business bad debt, deducting the loss on the Schedule ... C or E ... related to the bank account from which the loan was made. Since the borrower was a tenant in the commercial building, the strongest case can probably be made that the funds were loaned in order to retain the borrower as a tenant.

See Regs §1.166-5(b) for more information regarding business and nonbusiness bad debts and the definitions of each.

[Sabre]

Tenant Loan

Roland I think you are spot on!

My client loaned the tenant $150,000 and was repaid about $3,000. The architect loaned the money to a builder -they had discussed doing projects together.

If I take it as a personal loan it will take him forever to realize any benefits of the money he has lost-certainly not what I base my decision on but a factor.

I am inclined more toward the rental schedule to record the loss. The schedule e has a profit of about $45,000 so I can at least absorb that- his other income puts him over the rental loss limitation but I can carry the residual over to future years so in about 3 years he will get benefit for this outlay.

Schedule C may just be going too far and subject to more IRS scrutiny-not what I base my decision on but a factor.

Roland- thanks for doing what you can!!

[Roland Slugg]

Hello again. So, the borrower was a builder and a client or prospective client of the architect business? In that case a Schedule C deduction looks like a reasonable alternative. In any case I would deduct the bad debt on the tax form that matches the disbursement of the funds ... assuming that your client does, in fact, maintain separate bank accounts and books for his rental property and his architecture business. (If he doesn't, he should.)

If the deduction goes on Schedule C, it will reduce the taxpayer's SE income and SE tax, unless he is over the annual maximum anyway, but even then it will reduce the Medicare portion of his SE tax.

A $147k bad debt deduction is a pretty big number, so you and your client should not be surprised if the IRS inquires about it. That's why you should think carefully about which schedule to report it on, and why matching the deduction to the entity that made the loan is a good idea.