Can a personal loan to a friend (that didn't get paid back) be deducted on taxes?

Topic 453 - Bad Debt Deduction

If someone owes you money that you cannot collect, you may have a bad debt. For a discussion of what constitutes a valid debt, refer to Publication 550, Investment Income and Expenses, and Publication 535, Business Expense. To deduct a bad debt, you must have previously included the amount in your income or loaned out your cash. If you are a cash basis taxpayer, as most individuals are, you may not take a bad debt deduction for income you expected to receive but did not because the amount was never included in your income. For a bad debt, you must show that there was an intention at the time of the transaction to make a loan and not a gift.

There are two kinds of bad debts â€“ business and nonbusiness. A business bad debt, generally, is one that comes from operating your trade or business. A business deducts its bad debts from gross income when figuring its taxable income. Business bad debts may be deducted in part or in full.

All other bad debts are nonbusiness. Nonbusiness bad debts must be totally worthless to be deductible. You cannot deduct a partially worthless nonbusiness bad debt. You must establish that you have taken reasonable steps to collect the debt and the debt is worthless. It is not necessary to go to court if you can show that a judgment from the court would be uncollectible. You may take the deduction only in the year the debt becomes worthless. A debt becomes worthless when the surrounding facts and circumstances indicate there is no longer any chance the amount owed will be paid. You do not have to wait until a debt is due to determine whether it is worthless.

A nonbusiness bad debt is reported as a shortâ€“term capital loss in Part 1 on Form 1040, Schedule D (PDF). It would be subject to the capital loss limitations. A nonbusiness bad debt deduction requires a separate detailed statement attached to your return.

For more information on nonbusiness bad debts, refer to Publication 550, Investment Income and Expenses. For more information on business bad debts, refer to Publication 535, Business Expenses.

Bad debts CAN be deducted. The problem you will have if audited is proving it was a LOAN and not a GIFT. A signed promissory note and/or records of payments would help.

There was only ONE correct response in all posted (the person who stated verbatim what IRS states)....

If you made a loan to a friend, you must be able to prove that it was indeed a loan. A cancelled check, or anything else which had the loan connotation attached to it will suffice. You do not provide this documentation to the IRS unless you are asked. However, you must show that you took all measures necessary to recover the loan. In addition, you must have 100% certainty that you will not ever get paid. Just because a person declares bankruptcy does not automatically mean you can write the debt off. Why? In a bankruptcy, creditors still have the right to be paid, if in settlement. So, if your friend borrowed a $1000 from you, but he declares bankruptcy. The bankruptcy court decides he will pay you $300. Thus, your bad debt writeoff will be $700. Once the bankruptcy court gives a settlement amount, the remainder is written off.

Now, you may have to attach a statement of bad debt to your schedule D. Understand, your bad debt loss (assuming non-business) is limited to amount of short term capital loss of $3K. For instance, let's say you loaned your friend 15K. He does not pay it back and declares bankruptcy. The bankruptcy court directs him to pay you 1K to settle out the debt. Thus, you would have a bad debt writeoff of 14K. Now, if you had no capital gains (from sale of stock, etc), you would only be allowed a 3K writeoff. However, let's assume you had a capital gain of 12K. So, in this case, you would write off all 14K. You can offset any gain with your loss, but you cannot have more than 3K as a loss. So in the above example, you would have a capital loss of 2K...

I hope that helps..

Documentation required for bad debt writeoff..

- Proof showing a loan
- Record of phone calls made to show collection attempts
- Copies of letters sent demanding repayment of loan
- If bankruptcy declared and order is final, secure a copy of that order to include..

REMEMBER... YOU DO NOT PROVIDE THIS INFO TO THE IRS UNLESS ASKED. The IRS gets suspicious when a taxpayer is TOO open with their tax records... This leads them to believe you have something to hide..

Hope that helps. e-mail if any questions...

One of the conditions of deducting a non-business bad debt is showing what steps you've taken to collect the money. If you can show the friend is bankrupt, then you don't really need to sue them. If they've got the money and just won't pay you...then you really need to sue. When you don't sue, the IRS can easily think it's because you like the person too much...and maybe this was a gift not a loan.

DO YOU HAVE A RECEIPT?

Sure â€¦. IFâ€¦. You have it in writing and signed as a valid loan, you can take it as a loss. Also, if you forgive the loan, your â€œfriendâ€ may be dinged by the IRS as having that as income.

No. If you want your money back - take him/her to small claims court. Of course, you may lose your friend in the process.

No, losses from personal loans are not tax deductible. You can only write off capital losses from legitimate investments, not person to person loans.

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