Question

Monty loaned his friend Ned $27,000 three years ago. Ned signed a note and made payments on the loan. Last year, when the remaining balance was $20,250, Ned filed for bankruptcy and notified Monty that he would be unable to pay the balance on the loan. Monty treated the $20,250 as a nonbusiness bad debt. Last year, Monty had capital gains of $8,100 and taxable income of $50,750. During the current year, Ned paid Monty $18,225 in satisfaction of the debt.

Determine Monty's tax treatment for the $18,225 received in the current year.

Answer 1

Monty's tax treatment of the $18,225 received from Ned, who originally could not pay the loan due to bankruptcy, depends on IRS regulations and would generally be recognized as income in the current year, with considerations for previously deducted bad debts and capital gains.

Step-by-step explanation:

Monty received a payment of $18,225 from Ned, who had previously been unable to pay off the balance due to bankruptcy. When Ned defaulted, Monty treated the nonbusiness bad debt of $20,250 as a loss, which would have been deducted against Monty's capital gains last year.

Given that Monty's capital gains were $8,100, the nonbusiness bad debt deduction would have been limited to this amount, creating a potential capital loss carryover. In the current year, the receipt of $18,225 would generally be recognized as income.