The rules for personal bad debt write-offs

For a bad debt to be deductible or written off, it must be a result of either actual money loaned or a loss on previously reported income. As a regular person, you will most likely be on the side of the debtor, or the person who accepted the loan and cannot pay it back. However, it is possible for you to write off a personal bad debt if you lent money to a friend or relative. It all depends on the paper trail and proper documentation.

To write off a bad debt, you need to prove the funds in question are actually a debt and not a gift. If you gave money to one of your children who is a minor (under the age of 18), this is a gift and not able to be written off. To be a debt, the funds cannot be something you have been expecting to receive. They must be funds you have parted with, so something like child support cannot be written off as a bad debt. The debt has to have come out of your pocket, and you need to have already taken steps to collect it. Just as a credit card company can charge-off a delinquent debt after six months, you can write off a personal debt owed to you if it has not been paid back six months after it was due.

There should also be ample paperwork to show the money is a debt and not a gift. A check is a legal document, so you’re off to a good start if the money you lent was offered via check or money order, and you also have a receipt to prove the loan amount. You’re just an average Joe, so it’s likely you didn’t kill a few trees to draw up a lengthy contract with microscopic print. However, by having your friend, family member, or other adult you lent the money sign a promissory note (saying he/she will pay the money back at the stated date), you have made a legal document that will prove beyond a doubt that the money is a debt and not a gift.

When writing off this personal debt, it is considered a short-term capital loss, and you will file it on Schedule D of your 1040 form. The capital loss maximum for each year is $3,000 ($1,500 if you are married and filing separately), and it is crucial to file in the year the debt became bad. You may also have to attach a statement which includes a description of the debt (amount and date it was due), the name of the debtor and any relationship with him/her, efforts made to collect the debt, and why the debt is now worthless (meaning the debtor is bankrupt or has recently lost a source of income or some other instance in which he/she is unable to pay). This is where your paperwork proving the debt comes in handy, as you can show how late the debt is and how many times you tried to collect on it. If successful, the write-off may result in a tax deduction. Don’t let this situation stop you from ever lending money to a friend. Just make sure you have documentation, and be familiar with the steps to take if you need another write-off.

David Pilley

David Pilley

David Pilley is a May 2010 graduate of the University of North Carolina at Chapel Hill, with a B.A. in communication studies and a creative writing minor. He is a native of Raleigh, North Carolina.

He played clarinet for the Marching Tar Heels in 2005 and 2006. He also volunteered for STV, the student-run television station at UNC-Chapel Hill, in the spring of 2010. He shot video, wrote scripts, and acted for “Off the Cuff,” UNC’s longest running sketch comedy show. He has the rare distinction of having lived in a dorm all four years of his undergraduate college career. He was also on Franklin Street on the night of April 4, 2009. His future plans are to pursue a master’s degree in journalism and to one day work for the media as a sports journalist or broadcaster.

Being one of eight children, David realizes finance is an important topic to everyone, regardless of his/her knowledge of the subject. His interests are in personal finance, budgeting, and savings.

In his spare time, David enjoys watching sports and standup comedy, as well as doing crossword puzzles and writing in the first person. He also thoroughly enjoys trivia and, one day, hopes to participate on the game show Jeopardy!, where he will try to break Ken Jennings’ 74-game win streak.
David Pilley

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