B is for Bad Debt (Personal)

We often think of bad debt in the business sense.  However, from time to time we run into a non business or personal bad debt.  Believe it or not, the IRS allows you to deduct this loss… but there’s a catch.  It is treated as a short term capital loss and therefore is subject to the capital loss limitations (you cannot deduct more than $3,000 of net capital losses from income per year).

In order to deduct the loss, you must prove the debt had value at the beginning of the year and no value at the end of the year.  You must make a reasonable attempt to collect the debt and make a demand for repayment in writing.  If the debtor is unable to pay, request a written statement from him stating that he will not be able to meet his obligation and the reason why.

 A statement outlining the following must be attached to the tax return in order to take the personal bad debt.

  1. Description of the debt, amount and date due
  2. Debtor’s name and taxpayer’s relationship to debtor (cannot be a child or similarly related party)
  3. Description of efforts made to collect the debt and,
  4. Explanation of why the debt is now worthless (such as bankruptcy)

As always, seek advice from your tax preparer when writing of a non business bad debt.  If prepared improperly, the IRS likely will not allow the deduction.

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