How to file a bad debt

[michaelmars]

1120 sold its assets in 2007 in exchange for a note, reported the entire sale and paid the tax. corp closed in 2008 and the sole shareholder took the note in exchange for its shareholder loans. Assume this was all done correctly.

in 1/09 the note became worthless due to the bankrupcy filing of the debtor.

Is this a line 21, a form 4797, or sch D item?

[michaelmars]

follow up, would his legal fees be added to loss or go on sch A

[kcjenkins]

It's an investment bad debt, looks to me. No cite, tho, it's late, I'm tired, and this was filing deadline for farmers day, so I'm beat. [And no, I still have one left to finish, but they did not bring me everything, so I'm going home anyway.] Tomorrow will have to be it.

[jainen]

>>would his legal fees be added to loss or go on sch A <<

Assuming some of his legal fees could be allocated to the collection of taxable interest on this note (an assumption for which there is no foundation in the original post), they would be deductible on Schedule A.

Speaking of assumptions, "Assume this was all done correctly" is kind of a whitewash. There are any number of correct ways to do a corporate liquidation, but when the sole shareholder says he'll just pocket all the assets because instead of investing he had actually only lent the money to his corporate self -- well, I would at least not make any assumptions as to what his basis in that note was.

[OldJack]

>>took the note in exchange for its shareholder loans<<

Is that your conclusion or was the note simply distributed in liquidation?

You are the only one with all the facts, you must take a position on his holding status.

Well anyway... remember the basics in your classification and status determinations. Business bad debts are generally deducted where business income is reported (not line 21). Non-business bad debts are deducted on Sch-D, subject to limitation. Well you knew that but maybe other readers need to be reminded.

My best guess is that when you review everything this will end up on Sch-D.

[michaelmars]

sorry for my delay i have been out of the office,

when the business wrapped up the balance sheet was left with the note receivable $115,000, shareholderloan payable $197,000, cash $84,000 and capital stock $2,000. i think rethinking it that the defaulted note is investment since it was taken in repayment of his loan balance but still not clear. if its business or investmetn loss. Jainan-yes there was interest on the note too

[cred65]

"Business bad debts are generally deducted where business income is reported (not line 21)."

Wouldn't the business bad debt be reported on Form 4797?

[OldJack]

It would appear to me that the taxpayer received the note in liquidation of his capital investment and is therefore now holding a note with a tax attribute as a capital investment. As such, I would suggest he is holding a non-business bad debt instrument only deductible on form 1040 Sch-D.

[michaelmars]

It would appear to me that the taxpayer received the note in liquidation of his capital investment and is therefore now holding a note with a tax attribute as a capital investment. As such, I would suggest he is holding a non-business bad debt instrument only deductible on form 1040 Sch-D.

i am going to go with this senario. the client has no personal tax for 2009 and probably none for 2010 thus we are just talking about an nol vs a capital loss carryover. i am going with the more concervative cap loss.

There was a lot of good imput on this topic thanks everyone.