lydia33 Posted November 17, 2008 Report Share Posted November 17, 2008 Taxpayer sells rental property on installment sale in 06. The person that bought the property went to bank and took out a mortgage on it. They have defaulted on the loan and now the property is selling at the court house. My client says that the installment loan is considered a second mortgage and he will not get any of the money unless it brings more than what is owed to the bank. This is his question.....Will he have a nonbusiness bad debt? I told him he has only paid taxes on the part that he has collected over the last two years. HELP! Quote Link to comment Share on other sites More sharing options...
JohnH Posted November 17, 2008 Report Share Posted November 17, 2008 If the client didn't get a first mortgage when he originally sold the property, he should be asking his lawyer why this wasn't done. I think the taxes are the least of his concern right now - he should be getting to the bottom of why he's in this situation and whether it may be salvageable. But if he's really in a second position, he also might be able to bid the property in if the courhouse sale doesn't yield enough to repay him. Depending on the actual numbers, FMV, etc, he might either get the property back at a good price or else be able to force the bidding high enough to get some of his mortgage repaid. He may actually be in a strong bidding position unless everybody involved (bank, buyer, lawyer, seller, etc) just compounded a bunch of dumb errors. Quote Link to comment Share on other sites More sharing options...
lydia33 Posted November 17, 2008 Author Report Share Posted November 17, 2008 I called him back and asked him why he was not the first mortgage. The person he sold it to went to the bank to borrow ALL the money owed to my client to purchase the rental property. They would not give him a 100% loan, so my client took a note for the balance as the second mortgage. If he does not get any of the money from the court house sale does he have a bad debt on the amount owed or do we just stop on the installment sale? Quote Link to comment Share on other sites More sharing options...
Jake Posted November 17, 2008 Report Share Posted November 17, 2008 If the house is gone, the only thing that he has left is a note receivable from the buyer. Assuming that the note is uncollectible and has no value, then he would have a capital loss that could be writen off against capital gains or against ordinary income ($3,000 per year). The basis would be the carrying value of the note when it became worthless. The sales price would be zero. Quote Link to comment Share on other sites More sharing options...
jainen Posted November 17, 2008 Report Share Posted November 17, 2008 >>does he have a bad debt on the amount owed<< Pub 537 explains that when an installment agreement becomes unenforceable it is treated as a disposition. You can not simply claim a loss for the unpaid balance. First multiply the balance due by the gross profit percentage, then subtract that figure from the balance due. The result is your basis in the installment agreement, and your loss is the difference between that basis and the FMV (presumably zero unless it was a related party). It's a capital loss if the rental property was treated as a capital asset. Be sure your client understands that losing the security does not necessarily make the note worthless, since he did not do the foreclosure. A lot of people these days are simply letting property be repossessed if the value has dropped to less than they owe, even though they still have substantial assets. Have a lawyer review the terms of the note, and consider pursuing collection on it. Quote Link to comment Share on other sites More sharing options...
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