Default promissory note

[tax newbie1]

I have a client that let a real estate developer borrow $50,000 in a form of a promissory note. The real estate developer filed for bankruptcy and defaulted on the note. How do I report this on his tax return? Do I treat this like a schedule D capital gains/losses transaction and subject to $3,000 limitation?

Thank you for your help

[kcjenkins]

The first question is what was the context of this loan? Was there a business reason for the loan? There are several court cases supporting taking business loss if there is a clear business relationship to the loan.

[OldJack]

Sounds like a non-business bad debt deductible only on 1040 Sch-D.

[tax newbie1]

Hi KC and OldJack,

The developer uses the fund to build restaurants, shopping center and hotel. It seems to me that he invested in a bad junk bond because there was no clear business relationship to the loan. The borrow promised to pay seven equal payments at a fix rate of 25% (it just too good to be true). Do you think it should go to schedule D?

Thank you for your help

[OldJack]

A non-business bad debt (promissory note personal investment) would be deducted on 1040 Sch-D subject to the $3,000 net loss limitation and carryover.

[jainen]

>>The borrow promised to pay seven equal payments at a fix rate of 25%<<

In my opinion, that's a felony called usury. As there was never any enforceable debt, there is no deductible loss.

[tax newbie1]

Thank you for all your helps. I will claim it as a non-business bad debt and deduct it on schedule D subject to $3,000 net loss limitation.

[michaelmars]

>>The borrow promised to pay seven equal payments at a fix rate of 25%<<

In my opinion, that's a felony called usury. As there was never any enforceable debt, there is no deductible loss.

HOW can 25% be usury if credit cards charge 29.99? i though 30% was usury. were you being sarcastic or is 25% the real number??

[chadw]

HOW can 25% be usury if credit cards charge 29.99? i though 30% was usury. were you being sarcastic or is 25% the real number??

I believe it depends on if the loaner is a qualified financial instituion. It also varies from state to state as well for the interest rates.

[OldJack]

I doubt a violation of the usury laws would negate the fact that the taxpayer has a deductible income tax loss. If it did why would a retail store theft loss be deductible.