It’s bad to experience a large loss on a business deal gone sour. But it’s even worse when you can’t use the loss to reduce your income taxes.

That was the situation of a client who was referred to me by the accountant he switched to after feeling underserved by his previous ones.

This very able professional couldn’t figure out a way to utilize the loss for the client, but he had the open-mindedness to think that there had to be a way, and he wanted me to take a look.

The client, a high-earning executive, had been approached in 2004 by a friend who wanted to buy, renovate and “flip” a multimillion-dollar home.

The client would supply most of the cash, his friend would oversee the renovation and, upon the sale of the property, they would divide the profits.

As often happens, the project took longer than expected.

Then, in 2008, the Great Recession struck. It froze the credit markets, plunged the global economy into a crisis, erased $16 trillion from the stock market, and pushed the real estate market into freefall.

There were no potential buyers for the house, and the financing for the work to finish the home had disappeared.

Compounding his problems, the client had quit his almost seven-figure job in 2007 to focus on real estate, just before the crisis hit. So he was without a paycheck, and had most of his wealth tied up in a half-share of a house that could not be sold.

In 2011, the house was lost to foreclosure.

When he filed his 2011 taxes, he deducted the roughly $4 million he had lost and, under the general IRS rules, the net losses not used in 2011 could be carried back for two prior years and then carried forward. But 2009 and 2010 were years in which he had almost no taxable income. Therefore, carrying back the loss provided no tax benefit.

That left him with a multimillion-dollar loss that he could carry forward against future earned income – but at only $3,000 per year!

Looking into the details of the client’s business relationship with his partner, I realized that half of the money he had put up was invested in the “flip” project – but the other half was a loan to his partner.

This was important, because there is another IRS rule regarding business losses resulting from worthless loans. This rule allows a taxpayer to claim a bad debt loss within seven years after the due date of the tax return for the year in which the loss occurred.

It was clear from the circumstances that the debt had become worthless in 2008. Therefore, the taxpayer had until at least April 15, 2016 to amend his 2008 tax return and claim the bad debt loss.

Thus, with the general two-year net loss carryback rules applied to the taxpayer's amended tax return for 2008, he was able to reclaim taxes he had paid in 2006 and 2007, the years when he had earned substantial income.

This resulted in the client receiving a refund of several hundred thousand dollars, including interest.

In the end, an open-minded accountant, creative thinking, and attention to the details flipped a huge loss into a sizeable refund.

By Mayer Nazarian