Question

In 2015, Samantha loaned her friend Lo Ping $15,000. The loan required Lo Ping to pay interest at 8% per year and to pay back the $15,000 loan principal on July 31, 2017. Lo Ping used the loan to start a clothing store. Lo Ping paid Samantha interest on the loan in 2015 and 2016. Although her store appeared to be very successful, her accountant continued to inform her that her business was barely making a profit because of its “high cost structure.” In early 2017, Lo Ping became suspicious of her accountant’s claims and hired a local CPA firm to examine her accounting records. The CPA firm discovered that Lo Ping’s accountant had embezzled $30,000. As a result, Lo Ping had to file for bankruptcy. It is estimated that Samantha will receive 30% of the amount she loaned Lo Ping and that the bankruptcy proceedings will conclude in either December 2017 or January 2018 Samantha also is considering whether to sell 200 shares of stock in late 2017 or early 2018. The shares are expected to generate a $2,500 loss. This is the only sale of stock Samantha anticipates making. Explain to Samantha why it is important to determine the date that the bankruptcy proceedings will be concluded before selling her 200 shares of stock.

 

Answer 1

Because the debt is unrelated to Samantha’s business, it is a nonbusiness bad debt. Nonbusiness bad debts are deductible as short-term capital losses in the year in which the actual amount of loss is known. No deduction is allowed for the estimated amount of the loss. Therefore, it is important for Samantha to know when the bankruptcy proceedings will be concluded. 

 

If the proceedings will conclude in 2017, she has a short-term capital loss of $10,500 [$15,000 x (1 - 30%)] from the bad debt in 2017. As a result, Samantha’s loss from the bad debt will exceed the $3,000 maximum capital loss deduction and the loss on the stock she might sell cannot be used in the current year. Therefore, if she believes that in 2018 the market price of the stock will increase, even marginally, she should wait until 2018 before selling it. However, if she believes that the market price of the stock will continue to decline in 2018, from a cash flow perspective she should sell the stock in 2017.

 

If Samantha knows that the proceedings will not conclude until 2018, she should sell the stock in 2017 to take advantage of the $3,000 maximum capital loss deduction. Unless she has other stock holdings that she is planning on selling in 2018, if she waits until 2018 to sell the stock, her total capital loss deduction for 2018 will be $13,000 ($2,500 + $10,500). The maximum she can deduct assuming no other capital gains is $3,000 and her capital loss carry forward to 2019 would be $10,000.

 The maximum she can deduct assuming no other capital gains is $3,000 and her capital loss carry forward to 2019 would be $10,000.