## Facts

- William Owens owned and ran Owens Financial Group, Inc. (OFG), a commercial lending company, and also made loans from his own funds (often through a personal trust).
- Between 1999 and 2013, Owens personally made at least 66 loans totaling more than $24 million.
- Owens conducted his personal lending through OFG: OFG employees handled communications, loan documentation, servicing, and legal work for Owens’s personal loans much like they did for OFG’s loans.
- In 2002, Owens began lending personally to David Lohrey, who owned West Coast Linen, a commercial laundry business, and Lohrey Investments, LLC, an entity used in connection with expansion.
- Lohrey Investments initially borrowed about $2.75 million from Owens. As the business expanded, it needed more cash, and Owens made additional advances over time.
- Lohrey Investments missed payments at points, but Owens continued lending because he believed the business could succeed and repayment would occur.
- By 2008, Owens had advanced roughly $9.5 million to Lohrey Investments (the amount he later sought to deduct as a bad debt).
- During the relationship, Owens’s position included features such as subordination to other financing and arrangements that gave Owens’s trust participation rights tied to the venture’s results, alongside the written loan instruments.
- In late 2008, West Coast Linen filed for bankruptcy and its operations stopped immediately. Lohrey told Owens that Lohrey Investments would also file for bankruptcy, which it did in January 2009.
- Owens ultimately recovered nothing from any bankruptcy proceedings.
- On his 2008 federal income tax return, Owens claimed a $9.5 million bad-debt deduction under I.R.C. § 166.
- The IRS disallowed the deduction, asserting that Owens was not in the trade or business of lending, the advances were not bona fide debt, and the debt did not become worthless in 2008. Owens petitioned the Tax Court.

## Issues

1. Was Owens engaged in the trade or business of lending money so that any worthless debt qualified as a business bad debt under I.R.C. § 166(a), rather than a nonbusiness bad debt under § 166(d)?
2. Were Owens’s advances to Lohrey Investments bona fide debt, or were they more properly treated as equity or another non-debt investment?
3. Did the debt become wholly worthless in 2008, the year Owens claimed the deduction?

## Decision

- The Tax Court held that Owens was engaged in the trade or business of lending money through his personal lending activity.
- The court held that Owens’s advances to Lohrey Investments were bona fide debt.
- The court found the debt became wholly worthless in 2008 based on the shutdown of operations, the borrower’s financial collapse, and the lack of a realistic prospect of recovery, even though Lohrey Investments filed bankruptcy in 2009.
- Owens was entitled to the $9.5 million business bad-debt deduction for 2008 under § 166(a) (with resulting NOL consequences addressed through the deficiency determinations).

## Legal Principles

- A business bad debt under I.R.C. § 166(a) is deductible as an ordinary loss; a nonbusiness bad debt under § 166(d) is treated as a short-term capital loss.
- An individual can be in the trade or business of lending money when the lending is conducted with continuity and regularity and with a profit motive; the inquiry depends on the facts, including the number and size of loans and how the activity is carried out.
- Use of an established lending office and staff to originate, document, and service personal loans can support a finding that the taxpayer’s personal lending is conducted in a businesslike manner.
- Whether an advance is debt or equity turns on the economic reality of the arrangement. Courts evaluate multiple objective factors (including formal notes, repayment terms, enforceability, intent, and the relationship of the parties); no single factor is controlling.
- Features such as subordination, unsecured status, missed payments, or participation-type returns do not by themselves convert an advance into equity when the overall arrangement still reflects a creditor-debtor relationship.
- For worthlessness under § 166, the deduction is taken in the year the debt becomes worthless based on all the surrounding facts; a bankruptcy filing can be evidence of worthlessness but is not required, and worthlessness may occur before a formal filing when recovery is not realistically expected.
- Filing a proof of claim in bankruptcy may show some hope of recovery, but it does not bar a worthlessness finding when other facts show the debt had no meaningful chance of collection.

## Conclusion

In *Owens v. Commissioner*, the Tax Court allowed Owens’s $9.5 million bad-debt deduction for 2008, finding that his long-running, profit-driven personal lending (carried out through OFG’s lending operations) rose to a lending trade or business, that the advances to Lohrey Investments were genuine debt despite distressed circumstances and deal terms, and that the debt became wholly worthless in 2008 when the laundry business collapsed and there was no reasonable prospect of recovery.


Owens v. Commissioner, T.C. Memo. 2017–157 (2017)