Tax deductions for bad debts of non-businesses
Updated to tax year 2024.
Have ever you lost money because of a loan that you will never be able to pay back? You’re not the only one who has done this. We’ve all lent money at one time or another to a relative or friend. Even though the intention was good, sometimes things don’t work out as planned. Even if you are not a business owner, you might be able write off bad debts. If the amount you lent was substantial, it’s possible to write off the money in the year the debt becomes uncollectible.
At a glance:
Even if you aren’t a business owner, you might be able to write off bad debts.
- To take a non-business bad debt deduction, you must have documents showing you had a legal debt that is now uncollectible.
- TaxAct(r) can help you deduct non-business bad debts.
- Step 1: Identify if it’s non-business or business bad debt.
Bad business debt is precisely how it sounds — debt from operating a trade or business. A non-business debt is anything else. Step 2: Determine whether you can claim this bad debt on your return. If you have failed to collect a debt after trying every reasonable method, it becomes uncollectible. It’s also deemed uncollectible if the borrower files for bankruptcy and the debt is discharged.
Once a non-business bad debt becomes uncollectible, it is considered completely “worthless,” meaning you have no chance of being repaid, and you can provide proof you guaranteed the debt to protect your investment. At that point, you can then deduct the bad debt on your tax return.
However, if you guarantee a debt as a friend with no consideration in return and the debt goes bad, it is considered a gift instead of a loan. Step 3: Document the bad debt.
To claim a bad debt tax deduction, you will need to prove that you had a legal, enforceable debt. Be sure to keep track of the following information:
Note or loan agreement proving you had a legal, enforceable debt:
You don’t need mountains of legal paperwork, but you will need to have at least one document showing there was an understanding with the borrower that you were to be repaid. If you don’t, the IRS may determine that you gave a gift. Note that you cannot deduct bad debts for money you never received, such as uncollected alimony. Note that you can’t take a bad debt deduction for certain money you never received, such as uncollected alimony.
Documentation showing you tried to collect on the debt:
Any letters, emails and notes from phone calls are examples of documentation that will work here.
- Additional documentation indicating why the debt is worthless: You can only deduct debts if they are totally worthless, so you’ll want any and all evidence showing the debt is worthless. You’ll need to keep the documentation if, for example the borrower has gone bankrupt to prove that the debt is worthless. You need to be aware of a few details. You cannot claim a debt for money that you expected to be paid by your sister for repairing her air conditioner, even though she had promised to pay. If you want to claim a bad debt on your return, you will need to complete Form 8949 Sales and other Dispositions Capital Assets. TaxAct can guide you through the process of claiming a non-business debt deduction. We will ask you to attach a statement detailing a description of the debt, debtor’s name and relationship to you, your efforts to collect debt and how you determined that debt was worthless. You can carry forward the amount of the deduction if you are unable to take it in the year that the loss occurred. If you have already filed your tax return, you will need to amend it by filing Form 1040X, Amended U.S. Return. Individual Income Tax return, with Form 8949 attached. If you collect on the debt, you may be able to count part or all of it as taxable income. You will only pay income tax on bad debts that reduce your tax. This could be less than the amount you deducted when you filed your return with the bad debt deduction.
- The bottom lineDealing with bad debt is never easy, but understanding your tax options can help soften the financial blow. You can recover some of the value you lost by following the right steps to document and claim your loss. Whether it’s determining if your debt qualifies, gathering the necessary documentation, or filing the right forms, the process may seem complex, but TaxAct is here to help guide you through the tax filing process — we can help you turn some of your financial losses into potential tax benefits.
- This article is for informational purposes only and not legal or financial advice.All TaxAct offers, products and services are subject to applicable terms and conditions.
