Does someone owe you money? Are you afraid you’ll never see it again, primarily because you have no way to collect the funds? You’re faced with “Bad Debt”. Don’t worry though, you are able to deduct bad debt at tax time, as long as you have previously included the amount in your income. You had to have actually received the money at some point, which means you can’t deduct rent or payment for services that you anticipated, but never actually got. You’ll also need to show proof that the money you lent wasn’t a gift, and that repayment was directly stated and understood by both parties.
Bad debt can be from business or personal situations. Business bad debt typically comes from operating expenses, and is deducted on your income tax form. This type of bad debt can include loans to customers, credit sales, business loan guarantees.
It’s still necessary to include these debts in your income, even with a business. Business debts are deducted using either the charge-off method or the nonaccrual-experience method, and can be deducted either partially or in full.
Other types of bad debt are considered nonbusiness related. In order to be deducted, they have to be completely valueless, meaning there is no reasonable expectation of repayment based on the facts. You’ll need proof that several methods were used to attempt to collect the debt appropriately. Bad debt deductions need to be taken in the year when the debt becomes worthless, and with the right proof, you can avoid court.
Nonbusiness bad debts are reported as short-term capital loss on a Form 8949, Sales and Other Dispositions of Capital Assets, along with a detailed statement regarding the bad debt and attempts to collect.