Reporting Hard Money Loan Default as a Loss

[Bryan Price]

Hi All,

I made the mistake of loaning a total of $550k about 3 years ago and have not been repaid, and am looking at my options for my personal tax return to report the loss as now I would consider the loan to be in default. I have signed paperwork documenting the original loan amounts, properties, etc. for 3 hard money loans and am waiting a state authority judgment regarding potential fraud. I believe if the loan had been repaid, the income would have been reported on a K1 form as interest. I will not be receiving any type of documents from who I loaned the money to, as that person is pretty much in hiding and dodging many creditors at the moment. 

As my original investment is a total loss, would I be able to deduct this on Schedule C to offset any W2 income? I worry that reporting a $550k loss - when I normally report about $750k in W2 income from my day job - will be a major red flag to the IRS.  However, it would be much more valuable to me if this loss were to offset ordinary income. I would feel a lot less pain if I could save ~$200k in taxes I would have already had to pay as part of my W2 income.

I know the answer is to consult a tax attorney and I plan on doing so, but I want to be armed with the most information possible.

[Jeff S.]

You still have some options, @Bryan Price, especially if the first-position lender has not yet foreclosed. Though it appears you did not speak to a lending lawyer before you made the loan, for $550k you should speak to one now.

Fortra Law and Doss Law, both in Irvine and both lending law firms, will be able to give you some options. You might call one before you give up on this loan. Obviously, you also need a CPA, but be warned that unless you have some large lending or other investment gains to offset this potential loss, you will not like what you hear regarding offsetting against W2 income.

You might have been taken advantage of, Bryan, but don’t assume fraud. I don’t know what state authority you’re talking about or where you made these loans, but deeds of trust and mortgages are public records that you could have easily found in advance on your own. Of course, they would have been noted on the preliminary title insurance reports you received when you made these loans. You did get title insurance and required the title company to record these loans in first position, right? And personal guarantees?

I hate to hear when someone takes advantage of a lender, especially a new lender. I apologize for my cynicism, Bryan. You still have some options, but after 3 years, time is not on your side. Don’t wait.