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Stephanie would have received had she sold the property for cash
subject to the Great Western first deed of trust and paid the
cash to petitioner. As discussed below, petitioner is entitled
to treat the excess of the Atascadero loan, $131,828, as a
worthless nonbusiness debt under section 166.
Section 166 allows a deduction for any debt that becomes
worthless within the taxable year. Sec. 166(a)(1). The parties
agree that the Atascadero loan was a nonbusiness debt. A
nonbusiness debt is any debt that is not created or acquired in
connection with a trade or business of the taxpayer. Sec.
166(d)(2)(A). In the case of nonbusiness debt, the deduction is
treated as a loss from the sale or exchange of a capital asset
held for not more than 1 year. Sec. 166(d)(1)(B).
Taxpayers seeking to avail themselves of the so-called bad
debt deduction must prove the existence of a bona fide debt, as
defined by section 1.166-1(c), Income Tax Regs., and that the
debt became wholly worthless during the tax year in which it was
deducted, sec. 1.166-5(a)(2), Income Tax Regs.
On reply brief, respondent insinuates that the loan payments
from petitioner’s profit-sharing plan to Stephanie and David were
gifts rather than bona fide debt. This position is diametrically
opposed to the characterization respondent has given the payments
since 1994. Throughout the course of the examination of the
profit-sharing plan and trust, the settlement discussions
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