Casual lender not allowed bad debt deduction.

• Author: Beavers, James A.
• Position: 2015 Tax Court memorandum decision in Cooper v. Commissioner

The Tax Court held that a taxpayer who made high-interest loans to friends and acquaintances was not entitled to any bad debt deduction in 2008 for a loan that arguably went belly up in 2008, because he did not prove that it was a business loan or that the loan was wholly worthless in that year.

Background

Fred Cooper was a full-time employee of USANA Health Sciences Inc. (USANA), serving as the company's president. He owned an eclectic mix of business interests, including rental properties, a car wash, a search engine optimization company, a pheasant farm, and a drug manufacturing company. In addition, Cooper over the years sporadically made loans to friends and acquaintances referred to him by two of his friends. He lent money on a short-term basis and charged high interest rates (up to a 40% annualized rate).

Cooper made 12 loans to 11 borrowers from 2005 to 2010, but he had promissory notes for only five of those loans. Cooper knew five of the borrowers before making the loans, and his friends introduced the other six borrowers to him. Cooper did almost none of the due diligence that would be customary in a lending business and did not conduct credit checks, verify collateral, or collect information through any loan applications before extending the funds. Cooper claimed that he made loans to individuals based on their character and whether he thought they had the ability and the willingness to pay him back.

Cooper also kept virtually no contemporaneous records of his loan activities. Despite his lack of due diligence and recordkeeping, he asserted that he devoted between 150 and 200 hours in 2006 to his lending activities and between 120 and 150 hours each year from 2007 forward.

One of the 12 loans was to Richard Wolper, who was the president of Wolper Construction, which performed infrastructure, sewer, water, road, and pipeline construction. Cooper made the loan to Wolper in 2005, and Wolper repaid the loan with interest in six months.

In March 2006, Cooper made a loan to Wolper Construction, which, according to the promissory note for the loan, was for $750,000 and came due in six months. The promissory note included a collateral guaranty in the form of a deed of trust on real property owned by Wolper Construction; however, no lien was recorded, and Wolper testified at trial that he did not believe any deed of trust was ever created. In October 2006, Cooper extended the loan for an additional six months, and Cooper and Wolper...