Can You Deduct Nonbusiness Bad Debt for a Lower AGI?
Any bank or business routinely writes off bad debt as part of the costs of doing business. In these cases, however, the loans have generally been well-documented, with formal applications for credit or promissory notes in their possession. Bad debt from personal loans, however, is also deductible, under certain circumstances, though the process is somewhat different.
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Types of Bad Debt
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Under Internal Revenue Service rules, there are two varieties of bad debt: nonbusiness and business. If the loan was made in connection with the operation of a business or a trade, then the loan falls under business rules. Otherwise, it falls under nonbusiness rules.
Declaring the Income
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Generally, if you want to deduct the nonpayment of a bad debt, the debt must have first been included in your income, or you must actually have loaned out cash, as opposed to inventory or goods. Otherwise there is nothing to deduct against.
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Documentation
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To claim a bad-debt deduction, you must be able to establish that the transaction was, in fact, a loan, rather than a gift. For this reason, it may be a good idea to document the transaction as a loan from the outset, via formal promissory note or letter of understanding.
Claiming the Deduction
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You can claim the deduction for a nonbusiness bad debt by filing an IRS Schedule D along with your IRS Form 1040 personal income tax return. To deduct a bad debt, the loan must be totally worthless.
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