Can I write-off a personal (nonbusiness) bad debt?

If someone owes you money that you cannot collect, you may have a bad debt. To deduct a bad debt, you must have previously included the amount in your income. 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, such as unpaid child support, rents or wages, because the amount was never included in your income.

There are two kinds of bad debts – 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. These nonbusiness bad debts must be totally worthless to be deductible. For example, if the debtor had your debt discharged under bankruptcy, or if the debtor skipped town and you cannot contact them, or if default occurred and collection costs would exceed what you are likely to recover. You cannot deduct a partially worthless nonbusiness bad debt. You must establish that you have taken reasonable steps to collect the debt and that the debt is worthless. You cannot simply choose to forgive the debt and write it off. 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.

Be aware that you may need to be able to prove that a legitimate debt was incurred to begin with. If the loan was made to a boyfriend/girlfriend, spouse, other relative or friend, the assumption will usually be that this was a gift, which you really did not expect to receive back. This can only be disproved by clear evidence, such as a promissory note stating a definite repayment period.

A nonbusiness bad debt is reported as a short–term capital loss. It is subject to the capital loss limit of $3,000 per year. This limit is $1,500 if you are married filing a separate return. A nonbusiness bad debt deduction requires a separate detailed statement attached to your return.

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