Bad Debt Loss?

[GTS1101]

My client owned two homes. In 2006 he sold one of those homes for 950,000. 15,000 was put down, a 1st was taken out for 735,000 and my client provided the 2nd to the home buyer in the amount of 200,000. There was a legal deed of trust done and it was notarized by a lawyer. It was at 7% interest rate. It was a 3 year loan. Interest only and then a ballon payment for the principal in the third year. The home buyer walked away from the home after a year and a half. He only paid half the interest. The house was foreclosed and the bank for the 1st loan took the house back. My question is can my client write off the 200,000 principal he lost as a bad debt loss? And would that be on Sch D capital loss using 3,000 a year for the next 60-70 years?

Thanks!

GTS1101

[krazykev]

Business purpose

I think you need to look at the circumstances surrounding the loan. If the client was lending this money with the intent of making money and you feel it can be backed up as a business debt then deduct it as a business bad debt. However, if there is no other similar business income to offset this bad debt it may be a stretch to justify. I had a client who provided "bridge loans" or short-term loans to individuals and businesses that needed to complete a home, etc., but couldn't get normalized bank funding until a certain stage of the project was reached. He was in this business to make money on the interest and had several loans out at one time. If this happened to my client I would have taken as business bad debt no question.

On the other side, if client was selling this house originally and just provided the 2nd mortgage as a method of selling the home or as a favor to a friend then it would seem it is non-business personal bad debt that would go on schedule D.

That's my .02 - good luck!