Trust deed investment - when can I claim a loss?

[JT Marlin]

I invested in several trust deeds back in the 2005 -2006 time frame. Unfortunately, several of the trust deeds were ultimately foreclosed on. However, there is one trust deed loan that hasn't performed in years, but the investors that made up the beneficiary LLC can not agree on whether or not to foreclose - there is some concern about inheriting liability on the unfinished project (primarily taxes).

My question is, for tax purposes, when can I recognize the loss associated with that trust deed investment? The loan was made at least 5 years ago and has been non-performing for at least 4 years. Does the trust deed have to be transferred or sold before I can claim a loss?

Elsewhere, I have some capital gains that I'd like to recognize if I can offset them with losses from the aforementioned TD. Can I declare the TD substantially worthless for a particular tax year, than if the TD is ever sold, recognize those proceeds as capital gains?

I know this is a convoluted question. I hope I was able to articulate the scenario in a fashion that made sense. I also recognize that I should consult my CPA (and I will). I'd like to get some thoughts from the BP collective as well though as my CPA is very conservative.

[Dave Toelkes]

Consult an attorney and your tax pro for definitive answers.

Unless you have something else in your hands, a deed of trust is just a legal document signed by the borrower which grants the lender the right to foreclose by power of sale in the event of default on the loan. No judicial action required.

I don't see that a deed of trust has any intrinsic value and I don't believe it can be foreclosed. The investors who hold the promissory note will realize the proceeds from foreclosure should they decide to go that route.

If you just hold the deed of trust, but not the promissory note, then how do you get paid? I don't see it.

Anyway, the answer to your question is NO. You can't just deem your "paper" worthless and take a tax loss before you have actually realized a loss.

You might be able to take some sort of bad debt write-off but you have to make a reasonable effort to collect first. Go to court, get a judgment and make some effort to collect. Only if your efforts prove unsuccessful, can you take a bad debt write off.

Just my opinion.