Question

Jezebel lanes her friend $7,000 to buy used car. She had her friend sign a note with repayment terms and set a reasonable interest rate on the note because she wanted her friend to understand that this was purely a loan and not a gift. Her friend is now on disability and has made it clear that she has no way of paying back the loan. How should Jezebel treat the bad loan for tax purposes?

Answer 1

Money loaned by Jezebel to her friend is a case of Non-business bad debt. Non business bad debt can be treated as short term capital loss if three conditions are met.
- The money was given as a loan and not as a gift
- The loan was given in cash
- No amount of loan is recoverable

Since in Jezebel's case, the conditions are met, she can claim the non business bad debt as short term capital loss (assuming she has no capital gains to offset them with) upto maximum $3000 for the current year and carryforward the remaining amount of $4000 to be deducted in future. In second year again Jezebel can deduct upto $3000 and remaining $1000 can be carry forward and deducted in the 3rd year.

(If there are any questions, kindly let me know in comments. If the explanation is to your satisfaction, a thumbs up would be appreciated. Thank you)