Dear Rick:
About three years ago I loaned my daughter $75,000 to buy a house. At that time, I wrote you and you told me that since this was a loan, I should have my daughter sign a promissory note, which I did. I also, following your recommendation, talked to my daughter and made sure she understood this was a loan and that I expected to be paid back, which she understood. Under the terms of our deal, my daughter was to start making payments in January. She did not make the payment, and basically told me that she had no intention of paying back the loan. My two other children are not happy with this, and want me to sue my daughter. I do not want to sue my daughter, but I do not know what else to do. I really don’t need the money, but I also don’t want to alienate my other two children. Other than suing my daughter, do you have any other suggestions that you can recommend? Can I write off my loss for tax purposes?

Elaine

Dear Elaine:
I do have another suggestion that I think may work for you. Since you said you really do not need the money, you might consider amending your estate plan. For example, if your estate plan says upon your death your three children divide the money equally, you can change the plan to take into effect that your daughter defaulted on the loan. In other words, you treat her default as part of her inheritance. By doing it this way, your other two children are not penalized for your daughter’s default. In addition, if you want, you can also factor in an interest rate. So your daughter’s share is reduced not only by the principal of the debt she defaulted on, but also interest that you could have earned if she had repaid the debt.

The reason I recommend amending your estate plan is to make it clear that this was a loan to your daughter; that you did not gift the money to her, and that she is in default.

Loaning money to family and friends is always a dicey proposition. Even in a situation such as this where everything is done right, problems can develop. That doesn’t mean you should never lend money to family and friends, it’s just that you have to understand the risks involved.

One question that I ask everyone who wants to loan money to family or friends is to contemplate if there is a default, would they sue their relative. In most situations the answer comes back no. Therefore, I tell those individuals that they should only loan money if they can afford not being repaid. If they are going to need that money for their health, welfare and support and they’re not willing to sue if there is a default, then I generally recommend that they don’t loan the money. After all, we are adults and we have to recognize there’s nothing wrong with saying no.

With regard to you writing the default off on your taxes, it is not that easy. The IRS requires that you try to collect on the debt. What that means in most situations is that you have to sue the person in default. Since you do not want to sue your daughter, it seems to me the IRS would deny you a tax deduction.

Good luck!

Rick is a fee-only financial advisor. If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com