Frank loaned Emma $5,000 in 2016 with the agreement that the loan would be repaid in three years. In 2017, Emma filed for bankruptcy and, based on available information from the bankruptcy court, it was estimated that Frank could expect to receive $.65 on the dollar. In 2018, final settlement was made and Frank received $600.
a. Assuming the loan is a business bad debt, what is the amount of and the nature of Frank's deduction in 2017?
b. Assuming the loan is a business bad debt, what is the amount of and the nature of Frank's deduction in 2018?
c. Assuming instead that the loan is a nonbusiness bad debt, what is the amount of and the nature of Frank's deduction in 2017 and 2018?
a. 2017 deduction—$1,750 ordinary loss ((1.00 - .65 = .35 expected loss rate) × $5,000 loan))
b. 2018 loss—$2,650 ordinary loss ($5,000 loan - $1,750 prior year deduction - $600 recovery)
c. In 2017, the loss is partially worthless, so no deduction is allowed until settlement has occurred. In 2018, the $4,400 short-term capital loss ($5,000 loan - $600 recovery) will be netted against other capital gains and losses. If there are no other capital gains and losses, the loss is limited to the $3,000 current year deduction.
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