Home buyer shafted?

[RZellers]

A couple gives another couple $25K as down payment on a house, meant to be a personal residence, in a private transaction. Some event occurs that prevents the transfer of a clear title. The sellers, instead of returning the money, file bankruptcy. Buyers are out $25K, with no foreseeable recourse.
As gain or loss on a personal residence is not a taxable event, it doesn't seem that a capital loss is in order... even at $3k per year. No charges were ever filed, so it also doesn't seem to meet the requirements for casualty/theft loss.

Am I overlooking something? I can't get them their $25K back, but I'd like to think of a way to get the loss.

[Possi]

Anybody?

I'm going to throw "bad debt" out there, but just for chatter! I don't know the answer...

[taxea]

I don't suppose they had a written contract or promissory note that included a clause agreeing the loan would not be included in a bankrupcy?
Why didn't your client fight it being included in the bankrupcy?
Clear case of: no good deed goes unpunished.
There is a possibiliy of criminal fraud if the loan was properly documented...

[Koss]

Shafted

Your clients may benefit from new legislation that is currently pending in Congress. HB 311 is known as the TRASH bill: the Tax Relief Act for Shafted Homebuyers. The House version is retroactive to April 1, 2009; the Senate version is not.



Okay, that was some pretty warped humor...

I don't think they have a loss on a personal residence, because they never bought the house. Based on your fact pattern, the sale was never completed. While the parties may have referred to the money as a downpayment, I think it was really a deposit, or what the real estate industry sometimes calls earnest money.

I agree with Possi. It appears to be a nonbusiness bad debt, which is in fact a type of capital loss.

Your clients are creditors. They have, or had, or could have had, a claim in the bankruptcy case. Maybe they actually filed a claim. Probably won't get a dime if there are lots of other creditors with higher priority debt.

Taxea raises some good points. They should have had a written contract of some sort; maybe they did. But even without anything in writing, that couple still owes your client $25K. Yes, the bankruptcy proceeding may have the effect of discharging the debt. But that's exactly what makes it a bad debt for your client.

Even if there was no written contract, that doesn't mean it's unenforceable. There has to be a paper or electronic trail showing the transfer of the funds. Oral agreements are legally binding contracts. You can't transfer ownership of real estate with an oral agreement; you have to execute a deed. But an oral agreement will hold up in court with respect to the disposition of a deposit. There was some sort of an agreement concerning that money, i.e., some sort of traditional understanding that the money would either be applied to the purchase, or if the sale did not take place, the money would be returned. That's the common law definition of a deposit, and that's what I think that payment was.

I think your client has a bad debt. If they never filed a claim in the bankruptcy case, and in fact they could have done so, and could have actually recovered some of the money, then that raises some fairly complex questions. But if they filed a claim and got nothing, or if it is clear from the bankruptcy case file that they would have gotten nothing, then I think they have a deductible nonbusiness bad debt. It's a capital loss, with a deduction of $3K per year, unless they have a bunch of other capital gains...

With that kind of money at stake, you would think that they would have at least talked to an attorney when they learned that the couple had filed bankruptcy. Any attorney would have told them to file a claim as a creditor in the bankruptcy case.

But even if they never filed a claim, they may still have a bad debt.

BMK

[LCP]

Who says it was meant to be a personal residence?

.... and even if they did who says they can't change their mind?

[BP.]

I'm going to throw "bad debt" out there, but just for chatter! I don't know the answer...

I'm in the Possi posse on this one- pursue the bad debt theory- see if your particular situation qualifies. TTB 8-6.

[Burke]

Discussion on other boards on this matter conclude that if the earnest money was for investment property, it is treated as a loss under Sect. 1234A and reported on Schedule D. For a personal residence, since losses cannot be realized under Sect 121 there is no deduction. Therefore, no deduction on Sche A either. And as far as a bad debt, I don't see how this fits that criteria. There was no loan to the seller, and no obligation for the seller to repay. I would look for anything in the purchase contract that might cover this eventuality.

[BP.]

Sorry- I misread the post as couple 1 loaning couple 2 funds for couple 2 (buyers) to buy a house, with the sellers being a third party. I don't think that is really the scenario. My bad!

[RZellers]

They tell me they got a lawyer & she said they went to a hearing, and were told they weren't getting any money. This whole thing was a real mess. The person they were buying the place from, also happened to be his employer at the time... and a "friend". Apparently, the paperwork was flimsy at best.

Wish we could get people to understand... the shorter the arms length of the transaction, the MORE important good docs are. In my experience, far more "friend" and "family" transactions go bad than unrelated party deals.

[taxea]

BP I read the post the same way you did and aftern seeing your post I went back and reread it.
couple 1 provided 25k to couple 2 who used it as partial payment on the private purchase of a home from party 3 who then filed a bankrupcy.

contracts or agreements, oral or written, surely must have occurred between 1 and 2 and then between 2 and 3. Written contracts would be more easily enforceable. Each of the parties 1 and 2, individually, need to seek legal advice as there may be either a civil or criminal act involved. Once this is determined, only then and with the proper documentation, would a loss claim be appropriate.

[BP.]

BP I read the post the same way you did and aftern seeing your post I went back and reread it.
couple 1 provided 25k to couple 2 who used it as partial payment on the private purchase of a home from party 3 who then filed a bankrupcy.

I know, right?

and Koss- TRASH bill. That was a scream.

[RZellers]

Sorry if my original wasn't clear. Not sleeping much these days, as I'm sure is true for all of us.

There is no 3rd party. Party 1 is the buyer, and party 2 was the seller. Party 1 gave party 2 the $25K, meant as a down payment on their home. Sellers backed out of the deal for whatever reason, and never returned the $25k down payment.

[Koss]

Loss of earnest money

I still say that it's earnest money, or a deposit--not a downpayment. The sale was never consummated.

The purpose of a deposit in this context is to demonstrate good faith on the part of the buyer. The seller takes the house off the market, and turns down other offers while the sale is pending. The common understanding is that if the buyer breaks off the deal, they forfeit the deposit. On the other hand, if the seller breaks off the deal, the deposit must be returned.

Burke noted that in other discussions of this issue, the consensus appears to be that loss of earnest money on a pending purchase of a personal residence is not a deductible loss. But I think that conclusion is based on the assumption that the buyer broke off the deal, and therefore had no right to a refund of the earnest money.

On your fact pattern, I think your clients had a right to get their money back. The sellers failed to complete the deal, and had an obligation to return the money. Their obligation to return the money may have been eliminated by the bankruptcy proceedings. But that makes it a deductible bad debt.

BMK

[Possi]

That's what I thought...

I still say that it's earnest money, or a deposit--not a downpayment. The sale was never consummated.

The purpose of a deposit in this context is to demonstrate good faith on the part of the buyer. The seller takes the house off the market, and turns down other offers while the sale is pending. The common understanding is that if the buyer breaks off the deal, they forfeit the deposit. On the other hand, if the seller breaks off the deal, the deposit must be returned.

Burke noted that in other discussions of this issue, the consensus appears to be that loss of earnest money on a pending purchase of a personal residence is not a deductible loss. But I think that conclusion is based on the assumption that the buyer broke off the deal, and therefore had no right to a refund of the earnest money.

On your fact pattern, I think your clients had a right to get their money back. The sellers failed to complete the deal, and had an obligation to return the money. Their obligation to return the money may have been eliminated by the bankruptcy proceedings. But that makes it a deductible bad debt.

BMK

I didn't overthink this one, as I often do (not) do.....
Great discussion.

[taxea]

These people got scammed...I still say it may be criminal and should be checked out that way before any "loss" is taken.