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Richard - Bizlaw
Richard - Bizlaw, Attorney
Category: Business Law
Satisfied Customers: 10607
Experience:  30 years of corporate, litigation and international law
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I had a person default on a note to pay for a business they

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I had a person default on a note to pay for a business they had purchased from me. Well, I won a judgement for $55,000 and they then declared bankruptcy. I only collected $1000 through the bankruptcy, and am now limited to simply live with the $3000 capital loss each year on my taxes. This all leads to my actual question. I have a similar situation happening with the second store I sold. I have not received payments for several months and the total is now up to about $10,000 he is behind on a $30,000 overall note. I am confident I could win a judgement, but am wondering about the legality of the three options I see available to me. They are: 1. Go to small claims court and get an easy judgment for $7500. If I do this, does this close me from future suits? 2. Go to court and win full judgement, and live with the $3000 captilal loss each year. 3. Simply keep sending monthly statements, & claim about $6600 each year on my income statement as "likely to be uncollectable?" Is this legal?
I suggest you contact the purchaser directly to see if you can work out a payment schedule. Failing that you can go to small claims court and seek judgment just for past due amounts. As other payments become due you can file additional suits. You can also declare a default on the note and sue for the entire balance and then attempt to collect. I assume you do not have any security interest in assets comprising the store as that would afford you the opportunity to foreclose on those assets and sell them at auction. On your third option, I assume you are a cash basis tax payer. In which case you would not recognize income until you received payment. If you are an accrual based tax payer, you could legitimately reserve the full amount of the obligation as a bad debt thereby eliminatnig any income. However, to the extent you receive any payment in the furture you will have to recognize that payment.
Customer: replied 8 years ago.

So even though I am on a cash basis, and have a promissary (sp) note saying he will pay me, I can not deduct the uncollectable monthly payments as a "bad debt" each year? This would offer me more benefit than either the first or second option.


There would be no assets that I would want back, and he has since turned over the operation of the store to someone else (though I do not know any specifics of their transaction). I do not expect to get anything from him, but am looking for the option that will give me the best benefit from a tax standpoint.

When you sold the store you engaged in a capital transaction. I assume you did not recognize any gain related to the $30,000 promissory note at that time. To the extent you had a gain it would be a capital gain (short or long term depending on how long you owned the store you sold). If you did recognize a capital gain that included the $30,000 promissory note, you would now write off the promissory note as uncollectible and offset any capital gain you had in the current year with the $30,000 capital loss. If the capital gain exceeded the $30,000 capital loss, you would reduce the current year capital gain by $30,000. If you did not recognize any income related to the $30,000 promissory note or had no other capital gains in the current year, then you will have a capital loss. If you have no other capital gains to offset with capital losses, you will only be allowed to deduct from ordinary income $3,000 each year. Whether you write off the full $30,000 at once or do it over several years, the result is the same. The capital loss deduction will only be greater than $3,000 if you have a capital gain to offset it. For example, assume you write off the entire $30,000 this year and have no capital gain this year. You will be limited to the $3,000 deduction against other ordinary income. However, next year if you have a $20,000 capital gain, you will be able to offset the entire gain with $20,000 of the $27,000 remaining capital loss you have. In addition, you can deduct the $3,000 against ordinary income. The result would mean that at the end of next your you would only have $4,000 of capital loss remaining to offset against further capital gains or ordinary income.
Customer: replied 8 years ago.

I think I understand what you are saying, and after this question, I will pay you accordingly.


I am already taking a $3000 capital loss each year from my previous sale. There is really very little activity in my S corp now. Therefore, I was hoping there was a way I could simply put the $6600 in missed payments each year in the "expense column" as an uncollectible debt, and realize a more immediate tax benefit. Am I hearing you say I cannot legally do that?


If I cannot do that, then my best next step is simply to go to small claims court each time he has nearly $7500 in payments due, and win a judgement for that specific timeframe. It is your belief that I can go back to small claims multiple times since the payments due are for different time frames. It is unlikely I will ever collect anything, but at the same time it saves me the expense of hiring an attorney to win the total note amount.


I appreciate your insight, and will pay you upon hearing your response to the above.


Thanks again!

You cannot convert a capital loss into an ordinary loss. I would pursue the small claims option and just sue for what is unpaid at the time. If you do not collect anything on the first judgment you can avoid any further expenditures. However, we you go to small claims court make it clear you are only suing for the unpaid payments and not the total amount of the note. Another is to distribute the note to your self individually and file in the regular court for the full amount of the note. Once you own the note individually, you do not need an attorney as the corporation will not be suing, just you.
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