How to write off a defaulted promissory note made by my single member LLC?

[Ojnor]

Several years ago, I made a loan through my single member LLC to a company to buy a house. The promissory note was secured by a deed of trust, but I was in 2nd position (never again). The house sold last year, but the borrower defaulted on the note since the house sold for less than what they paid for it. Since this was a business transaction, how do I take the full amount off my taxes and how do I report it in TurboTax?

[AmyC]

Topic no. 453, Bad debt deduction explains which debt is allowed to be deducted. For instance, if you made this loan without the legal paperwork or to your sibling, it wouldn't really be a business debt.

Full details are in Publication 334 which states:

Types of Business Bad Debts

Business bad debts may result from the following.

Loans to clients and suppliers.

If you loan money to a client, supplier, employee, or distributor for a business reason and you’re unable to collect the loan after attempting to do so, you have a business bad debt.

Debts owed by political parties.

If a political party (or other organization that accepts contributions or spends money to influence elections) owes you money and the debt becomes worthless, you can claim a bad debt deduction only if all of the following requirements are met.

You use an accrual method of accounting.

The debt arose from the sale of goods or services in the ordinary course of your trade or business.

More than 30% of your receivables accrued in the year of the sale were from sales to political parties.

You made substantial and continuing efforts to collect on the debt.

Loan or capital contribution.

You cannot claim a bad debt deduction for a loan you made to a corporation if, based on the facts and circumstances, the loan is actually a contribution to capital.

Debts of an insolvent partner.

If your business partnership breaks up and one of your former partners becomes insolvent, you may have to pay more than your pro rata share of the partnership's debts. If you pay any part of the insolvent partner's share of the debts, you can claim a bad debt deduction for the amount you paid that is attributable to the insolvent partner's share.

Business loan guarantee.

If you guarantee a debt that subsequently becomes worthless, the debt can qualify as a business bad debt if all of the following requirements are met.

You made the guarantee in the course of your trade or business.

You have a legal duty to pay the debt.

You made the guarantee before the debt became worthless. You meet this requirement if you reasonably expected you wouldn’t have to pay the debt without full reimbursement from the borrower.

You received reasonable consideration for making the guarantee. You meet this requirement if you made the guarantee according to normal business practice or for a good faith business purpose.

Later it gives the details for How To Claim a Business Bad Debt

There are two methods to claim a business bad debt.

• The specific charge-off method.
• The nonaccrual-experience method.

You will need to read through and see which applies to your situation. If you are a Sch C filer, you are probably a cash basis taxpayer. If you are an S-corp, you could be cash, accrual, or a version of them.