Tax Deduction for Bad Debts

By | March 7, 2015

If someone owes you money that you can not collect, you might have a bad debt and can use this to offset income. For a description of what is considered a valid debt, see Publication 550 , Investment Income and Expenses (Income and capital expenditure) and Publication 535 , Business Expenses (Business Expenses). Usually, to deduct a bad debt, you must have previously included that amount in your income or have paid the amount in cash.


What is the Tax Deduction for Bad Debt?

If you are a taxpayer cash basis, can not take a deduction for a bad debt for money had hoped to receive, but received (eg money owed for services rendered or rent), since the amount was never included in your income. To claim that there is a bad debt, you have to indicate when the transaction that was a loan and not a gift. If you lend money to a relative or friend with understanding that the friend or relative may not pay, you should consider it as a gift and not a loan.


Types of bad debts – commercial and noncommercial

Usually a bad commercial debt is the resulting performance of your trade or business. You can deduct this debt on their tax return business. The following examples are considered uncollectible trade receivables (if the amount previously included in income):

  • Loans to customers and suppliers,
  • Credit sales to customers or
  • Secured business loans.


Taking Bad Debt Tax Deduction

A business takes its bad debts from gross income when calculating taxable income. You can deduct all or part of uncollectible trade receivables. You can claim a bad commercial debt using the method of canceling tally bad experience or accrual method based on the risk of the amount to be collected.

All other bad debts are not commercial. To be deductible, these non-commercial debts have to be uncollectible in full. You can not deduct a noncommercial bad debt that can partially recover.


When is Bad Debt Uncollectible?

A debt is uncollectible when facts and circumstances around it indicates that there is no possibility that the amount due is paid. To demonstrate this, we must establish that it has taken reasonable steps to collect the debt. No need to go to court if you can show that the verdict would establish that the debt would be uncollectable. You can take the deduction only in the year in which the debt is uncollectible. No need to wait until the maturity of the debt to determine what is bad.


Declaring noncommercial bad debt

Declare a noncommercial bad debt as loss of short-term capital on line 1 of Part 1 of Form 8949 ,Sales and Other Dispositions of Capital Assets (Sales and other dispositions of capital assets). Enter the name of the debtor and the English phrase ” bad debt attached statement “(attached statement of bad debt) in column (a). Enter your bad debt based in column (e) and enter zero in column (d). Use a separate line for each bad debt. This loss is subject to limit capital losses.The deduction of bad debt noncommercial requires a separate and detailed explanation, which is attached to your return.

More information about nonbusiness bad debts

For more information about nonbusiness bad debts, see Publication 550 , Investment Income and Expenses (Income and capital expenditure). For additional information about business bad debts, see Publication 535 , Business Expenses (Business Expenses).