Bad Debt and Credit Loss

[Anthony Fontana]

When underwriting a commercial property, what is an example of bad debt and what is an example of credit loss (how does this differ from vacancy loss)?

Thanks

[Noah Krietsch]

Anthony,

I agree with Oleg on what an actual bad debt/credit loss is. 9 times out of 10 is when a tenant doesn’t pay their rent. 

I remember when I first saw these bad debts/losses when I first started underwriting deals, I was quite confused on what the hell it was. 

I kept thinking that people were essentially double hitting themselves because the "bad debt" isn't being collected in the income column AND they are counting it as a loss in the expense column. Kind of like when depreciation is included on the T12 statement sometimes (which means nothing to the prospective investor, the depreciation clock resets as soon as property changes hands anyways); that depreciation "loss" is not an actual expense, and neither is that bad debt. I THINK the owner is writing off the bad debt on their taxes somehow and that's why it's on their profit loss statement

I am still a bit unclear on this though, because in the research I’ve done, it still seems odd that people are reporting bad debts because per the IRS “Generally, to deduct a bad debt, you must have previously included the amount in your income or loaned out your cash. If you're a cash method taxpayer (most individuals are), you generally can't take a bad debt deduction for unpaid salaries, wages, rents, fees, interests, dividends, and similar items.” I would really like to get a CPA’s take on this.

Ultimately, I just ignore the bad debt / credit losses entirely when I'm underwriting based on Actuals because that will artificially deflate the NOI. The same way I don't include depreciation as an expense when I'm underwriting a deal to understand the NOI of the property as it is being ran by the current owner. Whatever tax schemes and strategies the current ownership is using don't really concern me; I just want to know the operating income and expenses and I can apply my own tax strategies accordingly should I acquire the property.