Now that you know what bad debt is, here's the skinny on how to deduct it from your taxes.
- In Part 1, you'll enter the name of the debtor and "bad debt statement attached" in Column A
- Enter "0" in Column D
- Enter the basis of your debt in Column E
- Make sure you use a separate line for each bad debt if you have more than one
The IRS requires a separate attachment, listing the following:
- A description of the debt, the amount, and the date it was due to you
- The debtor's name and his/her relationship to you (remember, the IRS almost always considers loans to friends and families to be gifts, unless you have paperwork showing otherwise)
- The ways in which you attempted to collect on the debt
- Why and how you determined the debt was worthless
What if you deduct bad debt on your tax return, but then later your debtor shows up and pays you back? Next time you file, you'll have to include that recovery as part of your income. The amount you report, however, is limited just to the amount you deducted. Report this recovery as "other income" on your tax form.
Of course, if you have any questions on how you should handle bad debt on your tax return, check with a trusted tax professional to ensure you follow the correct procedure.