Play Meter

Tax Clinic:
Treat unpaid loans
as short term losses
QUESTION: How are unpaid loans
to children or friends treated for tax
purposes?
ANSWER:
A nonbusiness bad debt
is allowed as a short-term capital loss
in the year in which the debt became
worthless. As a short-term capital
loss the nonbusiness bad debt ts
subject to limitations for losses and
will offset short-term capital gains.
In order to claim a short-term
capital loss for a nonbusiness bad
debt. you must establish that the debt
was one ansmg from a true
debtor-creditor relationship and was
based upon a valid and legally
enforceable claim. In addition, you
must establish that you used all
reasonable efforts to collect the
unpaid loan, wh ich efforts, however,
were unsuccessful.
overcome the presumption and
obtain a nonbusiness bad debt
reduction.
In addition to the above, advances
to your minor children to help them
pay for necessities such as food,
clothing. tuition. and medical expen-
ses generally are not a valid basis for
the bad debt deduction.
If the basis of your advance to
your child or friend is truly a loan, all
necessary steps to document the
inten t of the advance as a loan
should be taken, including causing
your child or friend to sign a
promissory note: and in the event of
nonpayment at maturity. employing
enforcement procedures. Frequent-
ly. because of the relationship
between the debtor and you, claim-
ing a bad debt deduction for unpaid
loans to your children or friends may
be difficult.
A gift canno t be the basis for the
nonbusiness bad debt since th ere is
no repaym ent obligation. In addition,
if an advance o f funds is m ade w ith
the understanding that r epaymen t of
the advance wi ll be forgive n , the
advance is consider ed a gift and not a
loan.
The regulations under the pr esent
Internal Revenue Code provide that
loans to children are presumed to be
gifts because of the parent-child
relationship. T he presumption is
rebuttable. however, and may be
overcome by you presenting con-
vincing evidence. For example,
assume that you made a loan to your
married son. evidenced by a promis-
sory note o n w hich he paid you
interest over several year s: however,
at m aturity of the note, your son filed
personal bankruptcy. U nder such
circumstances. you may be able to
PRIZE REDEM PTION & T RADE CHECK S
CASINO SLOT & GAMIN G COINS
P ho ne or wrl te for c a tolog & samples
VAN BROOK OF LEXINGTON, INC.
P .O. BOX 5044, LEXINGTON, KY. 40555
( 606) 255-5990
PLAY METER, March, 1980
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