guarantor of debt required to pay due to default

[skip]

Client guaranteed payment of line of credit. Debtor defaulted. Bank demanded payment from guarantor. Is the payment a non-business bad debt? And if so what is required for a supportable deduction on 1040?

[Burke]

I don't believe the debt payment is deductible. He signed for it, and was just as liable as the first guy when it was not paid. Unless he had a separate legal agreement with the person for whom he co-signed the note -- which he could take to Small Claims Court -- I think he is out of luck.

[Snaggletooth]

Business Connection

Burke, you are usually correct. I'm wondering if your answer would be the same if the guarantor had a business relationship with the debtor, and co-signed in order for the debtor to make a transaction which was mutually beneficial...

Skip is from Waverly, TN? I have a son in Dickson.

[Roland Slugg]

Is the payment a non-business bad debt?

Well, if the T/P made the guarantee agreement in the course of his business, he's entitled to a business bad debt deduction for any payments of principal or interest he makes as guarantor. (Regs §1.166-9(a)) If he made the guarantee agreement in a transaction for profit (but not in the course of his business), and makes a payment of principal or interest, he's entitled to a nonbusiness bad debt deduction in the year his right of subrogation becomes totally worthless. The term "transaction for profit" means one in which the guarantor received reasonable consideration in exchange for his guarantee. (Regs §1.166-9(b) and §1.166-9(e)(2))

[Burke]

Roland is correct. And there may be a circumstance, say in the course of a buyer of a home taking over the outstanding mortgage of the seller (which the bank still requires the original owner to guarantee) and that buyer defaults causing the home to be sold at an amount less than the outstanding mortgage. So the seller must ante up the difference. But the OP said "line of credit" and no further details, including his comment "non-business bad debt." So I assumed it was a personal situation.