Loan to "friend" loss

I am disabled and probably a little to gullible. I loaned money to "friend" trying to help him through some hard times. He swore up and down that he would pay me back and even signed a contract. Then he kept hitting me up for money for this crisis and that emergency until I have loan him many thousands of dollars that probably shouldn't have.

I found later that may "friend" has pretty much lied to me about a lot of things and then used quite a bit of the money I loaned him to buy heroin. He is off the drug now and still swears up and down that he will repay me. But, he has failed to hold a job for long and has pretty much no means to pay me back so far.

So, I'm trying to cut my losses as much as possible. I kept good records of all the money I loaned him. If I added up all of what the owes me and had him sign a promissory note or contract that says he owes me this money but has not been able to pay it back, can I deduct the money I loaned him from my taxable income?

Also, if I have to report to the IRS the name of the guy the loan was too, will they make him pay income tax on it?

Finally, if am able to write this loan off as a loss and he begins paying me back at some time in the unforeseeable future, would I then report that as income? Thanks for your help.

Answer : 

1 : In general, The IRS categorizes losses on loans as business or nonbusiness bad debt. As you provided the friend with a loan, that loan is a personal debt, and the IRS uses special tax rules for deductibility. Generally, the IRS allows taxpayers to deduct all losses from business loans but limits the deductions for non-business loans.Your loan, a nonbusiness bad debt, is deductible as short-term capital losses and require you to use Part 1 of IRS Form 1040, Sch D/Form 8949, if deductible. Taxpayers who are able to satisfy the IRS rules for deducting non business bad debts must use the federal tax rules for capitalizing the debt over several tax years. In addition to completing Sch D/form 8949, you must attach a written statement of the specific circumstances leading to the debt. According to the IRS, personal loans are worthless when there is no reasonable expectation or chance of recovery. The IRS will review all of the surrounding circumstances to determine whether there is a reasonable basis for believing the debt is uncollectible and worthless. You must prove you have taken reasonable measures in attempting to collect payment. The IRS does not require you to have attempted collecting losses through actual litigation, but you must show that litigation would be futile. You can show that obtaining a court award would not lead to collecting the bad debt because the debtor is insolvent, lives in another jurisdiction or the you are unable to locate the debtor. You fully deduct capital losses against capital gains on Form 1040, Sch D/from 8949. Your allowable capital loss tax deduction on your tax return for any tax year, figured on Form 1040, Sch D, is limited to the lesser of: $3K ($1.5K if you are married and file a separate tax return), or Your capital loss as shown on Form 1040, line 18 of Sch D/from 8949. If you have a capital loss on Form 1040, line 18 of Sch D/form 8949 that is more than the yearly limit on capital loss tax deductions, you can carry over the unused part of the tax deductible capital loss to later tax years until it is completely used up.

2 : While borrowing money isn’t regarded by the IRS as income, as he doesn’t pay it all back, the unpaid balance is his taxable income ;for example, you loaned your bud, say, $10K and your bud only pays back $5K. The day you give up trying to collect and write off the $5K, as far as the IRS is concerned, your bud made $5K. It’s the same as if you'd bud’d won $5K in a contest, or at a casino. In short, your bud’s $5K richer, and the IRS treat it as taxable income for your bud.HOWEVER, there are exceptions..Read More..