How to Claim a Bad Debt on a Personal Tax Return
- 1). Establish the legitimacy of a debtor-creditor relationship. In other words, the debt must be based on a valid and enforceable obligation to repay a fixed or determinable amount of money. This is especially important when making a loan to a friend or family member. You must demonstrate that the money could not be considered a gift. The best way to do this is with a written agreement, signed by both parties, stating the amount of the loan and the terms of repayment. If you can't show evidence that the transfer of money was intended as a loan with the expectation of repayment, you won't be able to deduct it as a bad debt if it becomes uncollected.
- 2). Document the attempts you have made to collect the debt. Keep copies of letters demanding payment, make notes on phone calls you make to the debtor, save evidence that you have attempted to locate a debtor who has disappeared or documents showing the debtor has declared bankruptcy to establish your intent to pursue repayment and the debtor's refusal to pay or a lack of any response.
- 3). Demonstrate that you have a basis in the debt. If you have loaned cash and you have documented the loan, the basis is automatically established. However, if an ex-spouse owes you court-ordered alimony or child support, for example, you can only claim it as a bad debt if you have already included the the amount you were entitled to in your gross income on a previous income tax return.
- 4). Claim a non-business bad debt on as a short-term capital loss on Schedule D of your personal income tax return. Include the debtor's name on Schedule D, line 1, and the words "statement attached " in column A. In the attached statement, include the debtor's name again, a description of the debt, the amount due and the date it became due. Disclose any business or family relationship you have with the debtor, the efforts you made to collect the debt and an explanation of why you have determined the debt is worthless. If you are claiming more than one bad debt, list each one separately and attach a separate statement for each. See the Resource section for more information.