Harry F. Hardy and Shirley Hardy, Petitioners v. Commissioner of Internal Revenue, Respondent, 54 T. C. 1194 (1970)

A nonbusiness bad debt deduction under IRC section 166(d) requires a bona fide debtor-creditor relationship with a valid and enforceable obligation to pay a fixed or determinable sum of money.

Summary

Harry and Shirley Hardy paid a $2,000 downpayment for a home that was not completed as specified. After refusing to close the transaction, they were ordered by a state court to pay $1,000 to the builder. The Hardys sought to deduct this amount and other related expenses as a nonbusiness bad debt under IRC section 166(d). The U. S. Tax Court held that no such deduction was allowable because there was no debtor-creditor relationship between the Hardys and the builder, and the state court judgment created a debt where the Hardys were the debtors, not creditors.

Facts

In April 1964, the Hardys contracted with ABC Builders to build a home in Rockford, Illinois, for $29,200, paying a $2,000 downpayment. The house was not completed as specified, and the Hardys refused to close the transaction despite taking possession. ABC Builders sued for specific performance, which was denied, but the court found the Hardys partially responsible for the loss, ordering them to pay $1,000 to the builder. The court also awarded the builder the Hardys’ improvements and ordered the downpayment apportioned between the builder and realtor. The Hardys claimed a $5,515 nonbusiness bad debt deduction on their 1965 tax return.

Procedural History

The Commissioner determined a deficiency in the Hardys’ 1965 federal income tax. The Hardys petitioned the U. S. Tax Court, which denied their deduction claim, ruling in favor of the Commissioner.

Issue(s)

1. Whether the Hardys are entitled to deduct the amounts involved as a nonbusiness bad debt under IRC section 166(d).
2. Whether a debt existed between the Hardys and ABC Builders that could qualify for the deduction.

Holding

1. No, because no debt existed between the Hardys and ABC Builders.
2. No, because the obligation created by the state court judgment made the Hardys the debtors, not the creditors, and section 166(d) only allows a deduction to the creditor.

Court’s Reasoning

The court applied IRC section 166(d) and the related regulations, which require a bona fide debt arising from a debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed or determinable sum of money. The court found no such obligation in the contract or any ancillary document. The Hardys’ claim rested on the builder’s obligation to return the deposit if it failed to perform, but this was not evident from the contract. The court clarified that the state court judgment against the Hardys created a debt, but they were the debtors, not creditors, and thus not eligible for a deduction under section 166(d). The court emphasized the necessity of a debtor-creditor relationship for a nonbusiness bad debt deduction, quoting the regulation: “A bona fide debt is a debt which arises from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money. “

Practical Implications

This decision clarifies that for a nonbusiness bad debt deduction under IRC section 166(d), a valid debtor-creditor relationship must exist. Taxpayers seeking such deductions must ensure they have a clear, enforceable obligation from the debtor. The case also illustrates that judgments against taxpayers do not create deductible debts for them as creditors. Practitioners should advise clients to carefully document any transactions that might result in potential bad debt claims. This ruling has been cited in subsequent cases to affirm the requirement of a bona fide debt for section 166(d) deductions, impacting how similar cases are analyzed in tax law.