A PROFESSIONAL SERVICES COMPANY OF
CERTIFIED PUBLIC ACCOUNTANTS AND BUSINESS CONSULTANTS
1966 Greenspring Drive/Suite 405/Timonium, MD 21093 410/453/5500 410/453/5522 Fax 800/772/1065 National www.nlgroup.com
How do I deduct a bad debt on my individual income tax return?
Nonbusiness creditors may deduct bad debts when they become totally worthless (i.e. there is no chance of its
repayment). The proper year for the deduction can generally be established by showing that an insolvent debtor
has not timely serviced a debt and has either refused to pay any part of the debt in the future, gone through
bankruptcy, or disappeared. Thus, if you have loaned money to a friend or family member that you are unable to
collect, you may have a bad debt that is deductible on your personal income tax return.
The fact that the debtor is a family member or other related interest does not preclude you from taking a bad debt
deduction, provided that the debt was bona fide and that worthlessness has been established. A direct or indirect
transfer of money between family members may create a bona fide debt eligible for the bad debt deduction.
However, these transactions are closely scrutinized to determine whether the transfer is a bona fide debt or a gift.
Bona-fide debt and other requirements for deductibility
You may only take a bad debt deduction for bona-fide debts. A bona-fide debt is a debt arising from a debtor-
creditor relationship based on a valid and enforceable obligation to repay a fixed or determinable sum of money.
You must also have the present intention to seek repayment of the debt. Additionally, for a bad debt you must
also show that you had the intent to make a loan, and not a gift, at the time the money was transferred. Thus,
there must be a true creditor-debtor relationship.
Moreover, nonbusiness bad debts are only deductible in the year they become totally worthless (partially
worthless nonbusiness bad debts are not deductible).