How to Write Off Loan Debt

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Any amount of money that you loan to an individual and yet do not receive back qualifies for a general write-off because it was once included in your income. When you write off a bad loan, you claim a tax deduction on the amount you did not receive. This allows you to recoup some or all of your loss through the deduction rather than waiting for the debtor to repay what he owes. The IRS then assumes the responsibility of collecting the remainder of the loan from the debtor.

Make a copy of the original loan agreement between yourself and the debtor. You must demonstrate to the IRS that you fully expected the debtor to repay the amount she borrowed.

Make copies of any proof that demonstrates that the debt is worthless. Although proof is not required, it supports your claim that the debt was once valid. An example of proof is a certified copy of a court judgment against the debtor for the unpaid loan balance.

Subtract any funds the debtor has already paid you from the total amount you originally loaned him. The resulting number is the amount of your bad debt deduction.

Enter the amount of your bad debt deduction in Part One of Form 1040 Schedule D, Capital Gains and Losses.

Write a statement to the IRS that includes any details about the loan that were not included in the original loan contract. If you do not have written proof that the loan debt is worthless, you may use the letter to notify the IRS of the reasons why you believe the loan is uncollectible.

Attach your written statement to Form 1040 Schedule D, Capital Gains and Losses. Include these documents with your taxes when you file your return.

Send the debtor a Form 1099-C, Cancellation of Income form, if the loan balance totals $600 or more. Once the debtor receives the Form 1099-C, she must include the unpaid balance of the loan in her annual income when she files her tax return.

Tips

  • You do not have to wait until the debt becomes worthless to claim it as worthless. If you have a legitimate reason to believe that the debtor will not be able to make payments on the debt, such as if he files for bankruptcy, you may assume the debt is worthless and claim it as a tax deduction.

Warnings

  • You cannot claim a bad debt deduction if you merely guaranteed a loan. You are only entitled to a tax write-off if you personally provided the loan funds.

    You cannot claim attorney fees, court fees or other additional fees on the loan as a tax write-off since these fees were not a portion of the original loan amount.

References

About the Author

Ciele Edwards holds a Bachelor of Arts in English and has been a consumer advocate and credit specialist for more than 10 years. She currently works in the real-estate industry as a consumer credit and debt specialist. Edwards has experience working with collections, liens, judgments, bankruptcies, loans and credit law.

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