How to Enter a Bad Debt Owed to Us on a Real Estate Property that We Owner Financed?

[Tax Tiger]

I am a Real Estate Broker with a property management company that qualifies & files our returns under the safe harbor election. We purchased a small multi-family property in our company name & sold it on the same day for a profit. We owner financed part of the amount of the sales price & the buyers signed a Promissory Note, which required them to make interest only payments with a balloon in 23 months. They only made 3 payments, so now they owe the interest payments + the principal amount. We have been unable to foreclose because the buyers used a hard money lender to purchase the property & the hard money lender took first position on the loan docs, which were filed of record. The buyers also stopped paying the hard money lender & they foreclosed on the property. We are left with a pretty sizable bad debt that will never be collectable. The title co sent a 1099-S with the gross sales price listed on it. I have to show that gross amount as income (income that is a lot higher than what we actually received) & we need to be able to offset some of that amount by showing that we have a true bad debt because the buyers defaulted. Where do I go to enter the bad debt amount?

Thank you!

[RobertB4444]

You're going to enter the sale of the home twice.  So it's a hassle but not the worst one.

The first entry is the home sale just as it was supposed to be,  You'll enter the interest that you received in the appropriate section and then you'll enter the home sale under sale of business property with the amount from the 1099-S as it is shown along with any closing costs, etc.  Basically as if the transaction had gone smoothly.  That covers what the IRS needs to see because of that 1099-S.

Then you will enter a second sale of the property.  The sale date should be the date that you were made aware (a letter from a lawyer or something is good for a date) that your note on the property was worthless.  If there is any hope for a partial recovery then the date of this sale should wait until you are sure (which it sounds like, in this case, you are).  The sale price is zero and the basis in the property is the sale price of the earlier transaction.  

When naming this sale it's a good idea to add 'default' to the sale name.  This will result in a loss that will wipe out the earlier gain that you entered and show the reality of the situation at the same time.

@Tax Tiger