Man counting perfectly stacked coins with different heights.
Lending money to family or friends can get a little tricky—especially if you still have to see them at the next family reunion. But if you made a legitimate loan and it’s clear you’re not getting that money back, the IRS may allow you to claim a nonbusiness bad debt deduction on your tax return.
So, how does it work?
Before you start writing off every unpaid IOU, there are a few important rules to understand.
It must be a real loan
The most important requirement is that the money must have been a loan—not a gift.
You can’t give money to someone and later decide it was a loan after things go south. The IRS looks at your intent at the time the money was given. There must have been a clear expectation that the money would be repaid.
To strengthen your position, it helps to have:
A written agreement or promissory note Repayment terms (even informal) Records of payments or attempts to collect
While documentation isn’t strictly required, it can make a big difference if your deduction is ever questioned.
You must try to collect
The IRS expects you to make reasonable efforts to get your money back.
This doesn’t mean you have to take someone to court—but you should be able to show you tried. Examples include:
Asking for repayment (texts, emails, letters) Setting up payment plans Demonstrating the borrower’s financial hardship
Situations like bankruptcy, job loss, or foreclosure may support your claim that the debt is uncollectible.
It must be completely worthless
A nonbusiness bad debt is only deductible in the year it becomes totally worthless.
This means:
You have no reasonable expectation of repayment, and The debt has no current or future value
Timing matters. If you claim it too early—or too late—you could run into issues with the IRS.
How the deduction works
Nonbusiness bad debts are treated as short-term capital losses.
This means:
They first offset any capital gains You can deduct up to $3,000 per year against ordinary income Any remaining loss can be carried forward to future years
How to report it
To claim the deduction, you’ll:
Report it on Form 8949 and Schedule D Attach a statement that includes: The amount of the debt Your relationship to the borrower How and when the debt was created Efforts you made to collect
For more details, refer to IRS Publication 550 (Investment Income and Expenses).
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