IRS Clarifies Tax Deductions for Worthless Personal Loans, Imposing Capital Loss Limitations
The Internal Revenue Service (IRS) has provided clarification on the tax deductibility of personal loans that become worthless, categorizing them as nonbusiness bad debts subject to capital loss rules. According to IRS Publication 550, a loan must be genuine, with a valid and enforceable obligation for repayment, to be considered deductible; informal understandings that repayment may not occur classify the transaction as a gift, which is not deductible. Furthermore, the debt must be entirely worthless, meaning no possibility of future repayment exists, for the deduction to be claimed. Partial worthlessness does not qualify for a deduction. The strongest evidence to support a loan claim includes a signed promissory note detailing the loan amount, interest rate, repayment schedule, and consequences of default, along with documented efforts to collect the debt. Without such documentation, the IRS may deem the transaction a gift, negating any deduction. The deduction must be claimed in the year the debt become...
