personal note discharged in bankruptcy. NOL for holder of the note?

[sdarave]

A client took a promissory note from a family member for $50000. The note defaulted and was discharged in bankruptcy court. My client was awarded $1110.00. Is the $48890 deductible as a NOL? Thanks for opinions!!!

[Burke]

Not as an NOL. He may have a short-term cap loss (i.e, bad debt.)

[TAX4US]

I would agree with Burke. I have only seen 1 time where it caused a partial NOL. I did not do that return so do not know what happened to trigger.

[taxea]

Can one take a loss when the bankruptcy kills the note?

[sdarave]

thank you for your suggestions

I appreciate your opinions, you validated my decision. I refer you to The Tax Book 1040 edition section 8-5.

[Roland Slugg]

If the loss is deductible, it's treated as a "nonbusiness bad debt" and, as such, is automatically defined as a short-term capital loss. But is it deductible at all?

The IRS is, understandably, very skeptical of claimed losses from loans to family members. The lender should be prepared to prove the loan was a bonafide loan, and not a gift, based on the facts and circumstances in effect at the time.

[Snaggletooth]

Don't Like It

This happens all the time to family members. I believe one standard of deductibility should be whether the loan was really a bankable loan at all. With income stream, collateral, credit rating -- all the things a bank would expect. I believe when you boil away all the BS, you'll find out the qualifications of the debtor was simply "I've got a pipe dream and I need money." This kind of situation destroys any presumption that it is an arms-length transaction.

[TXEA]

This will require substantial documentation to prove up the deduction. You will need to prove that the debtor had the capacity to repay the loan at the time the loan was made. Your post does not seem to indicate how long the debt was outstanding, the purpose of the loan, and whether any payments of interest were made? All of this should be documented.

Since the debt was discharged in bankruptcy, I am assuming there was a loan agreement. What were the terms of repayment, the date of the original loan, interest rate, etc.?

It is important to understand that just because this was discharged in bankruptcy, the loss does not necessarily become a deductible capital loss. I would recommend digging a little deeper.

[taxea]

You did mention a promissory note. Does it detail the terms? Was it signed? Are there records of prior payments made? Do the bankruptcy docs allow the lender to issue a 1099C?
Roland are you saying that the loss could still be taken even if the note was made uncollectible by the bankruptcy?