| It is possible that you may advance some money as a | | | | understanding, then it becomes a gift transaction and |
| loan. Later you find that there is no chance of | | | | not a loan. |
| recovering the money back. You can then claim a | | | | If you are fulfilling these conditions, you can go ahead |
| deduction for such an amount. IRS calls it a | | | | to claim that deduction for such bad debt. This |
| non-business bad debt. There are certain conditions | | | | deduction is claimed as a short term capital loss it |
| to claim such deduction: | | | | needs to be inserted on schedule D of your tax |
| 1. The money loaned must be out of your income | | | | return. On the schedule you give the name of the |
| previously included on your tax return. So if you are | | | | person and the amount which is bad debt. Then you |
| following cash method of accounting, which generally | | | | attach a statement in which you give the particulars of |
| salary taxpayers follow, you cannot claim this | | | | debt. They include the nature of the debt, the name |
| deduction. | | | | of the person, the date on which it was due; the |
| 2. The debt must be a valid and legally enforceable | | | | efforts made to collect and finally your opinion on why |
| obligation. It should have come out of your personal | | | | it is worthless. |
| transactions and not out of the business. | | | | There is no need to wait until the debt becomes past |
| 3. The total debt must have become worthless. So if | | | | due. Suppose the person to whom you have |
| you recover part of the amount, you cannot claim | | | | advanced the money files bankruptcy before such |
| deduction for the balance. This is a very | | | | date, you have a valid reason to claim the debt as |
| unreasonable condition. So if you get some money, | | | | worthless. Also, you can claim deduction for any |
| you cannot claim the loan as worthless. | | | | expenses you incurred towards the collection like legal |
| 4. There is more need to file a lawsuit to claim such a | | | | expenses. |
| deduction. You can claim on the basis of prevailing | | | | As discussed, this amount has to be claimed in the |
| circumstances. So if the person to whom you have | | | | year in which it becomes worthless. If you miss out in |
| lent the money becomes bankrupt, that is sufficient | | | | that year, there is no need to get worried. You can |
| evidence for you to claim deduction. | | | | still claim that deduction by filing an amended return in |
| 5. The debt must be bona fide or genuine. So there | | | | the subsequent years. You can file such an |
| should be a valid debtor creditor relationship. The | | | | amendment within seven years from the date you file |
| main purpose behind this condition is – when you | | | | your original return or within two years from the date |
| made such a loan, you believed it to be repaid. If you | | | | you paid tax, whichever is later. |
| have lent the money without any repayment | | | | |