Business or Non-Business Bad Debts

[nkustura]

I have a client whose business is a wholesale of computer parts to countries outside of US, mainly Turkey and some other European countries. A couple of years ago, client (partnership) attempted to do a business with a guy in Russia (I believe) whom my client gave close to $1M as a loan to start the business in Russia so my client can sell parts to a new Russian business. Well, the guy pretty much never opened up a business nor re-paid my client. Apparently there was a lawsuit that my client started, but still couldn't get the guy to pay back. My client states that he has court records of the lawsuit and can prove the he took reasonable steps to collect the debt.

My questions is whether this is a business or non-business bad debt? How should this be written off on tax return? In total or prorated over number of years, hoping that money could be collected some day???

Thanks

[Kram BergGold]

My thoughts

To me, it is a business bad debt but you can't write anything off until there is no hope of recovery.

[JON]

Good question

your client is not in the business of making loans, and the loan was not made to proterct his position (salary) within his company, but a business casualty loss?? The loan has to be completely worthless to do anything with it... Get the knowledge guys in here..

[nkustura]

Worthless Loan

So if the loan is determined to be worthless, how will it be written off? Can it be pro-rated over certain number of years? or does it have to be written off completely in a year in which it was worthless? I have been doing some research on this and it sounds like if it's a business loan it can be written off over a period of years or all in one year, but if it's non business bad debt it has to be written off to short term capital loss in total.
Thanks

[Burke]

What research have you uncovered that mentions pro-rating the loan? If it is taken all in the year it is deemed worthless (which it probably is -- $1M to a Russian, come on.....) then it would produce an NOL for carryback or carryforward, I would think.

[Roland Slugg]

Based on the limited facts given it sounds to me like a business bad debt. If so, it is deductible in full in the year it becomes worthless ... and ONLY in that year. That might have been the same year the funds were advanced. It is possible to take a deduction for a partially worthless business debt, but that does not appear to be the case here.

Documentation is important in a case like this. The T/P must be able to demonstrate that the debt became worthless in the year it's deducted.

See Code §166(a)(1), Regs §1.166-2(a) et al.

Burke: What makes you so sure this will produce a NOL? Maybe this business usually turns a profit of $5M, and this loss will just reduce that to $4M. Or since the business is a partnership, it might result in a NOL for one (or more) of the partners but not for others. Partnerships themselves don't have NOLs.

[nkustura]

What research have you uncovered that mentions pro-rating the loan? If it is taken all in the year it is deemed worthless (which it probably is -- $1M to a Russian, come on.....) then it would produce an NOL for carryback or carryforward, I would think.

Thank you for your response. Pub 535 talks about business bad debt and how it can be written off using a charge-off method, or total worthless method....."If you use the specific charge-off method, you can deduct specific business bad debts that become either partly or totally worthless during the tax year. However, with respect to partly worthless bad debts, your deduction is limited to the amount you charged off on your books during the year." This is where I was thinking that bad debt could be pro-rated to few years, until it is certain that the entire amount is worthless.
The loan was to a guy who was supposed to start the business in Russia (not necessarily Russian). The guy apparently attempted to start the business there, but never came through with operations. This is just what I've heard from the client. This loan has been on the books for a while so it's not like it happened last year.

[nkustura]

Based on the limited facts given it sounds to me like a business bad debt. If so, it is deductible in full in the year it becomes worthless ... and ONLY in that year. That might have been the same year the funds were advanced. It is possible to take a deduction for a partially worthless business debt, but that does not appear to be the case here.

Documentation is important in a case like this. The T/P must be able to demonstrate that the debt became worthless in the year it's deducted.

See Code §166(a)(1), Regs §1.166-2(a) et al.

Burke: What makes you so sure this will produce a NOL? Maybe this business usually turns a profit of $5M, and this loss will just reduce that to $4M. Or since the business is a partnership, it might result in a NOL for one (or more) of the partners but not for others. Partnerships themselves don't have NOLs.

Thanks for the response. I have read through the Regs you suggested. Do you think this business bad debt can we written off using a charge of method over a period of years, as the debt could be partially collected?