Can I deduct a personal loan that was never repaid?

Often yes, as a nonbusiness bad debt. The IRS treats it as a short-term capital loss claimed on Form 8949 and Schedule D in the year the debt becomes totally worthless. It offsets capital gains first, then up to $3,000 of ordinary income per year, with any remainder carried forward to future years.

What does totally worthless mean?

That there is no reasonable prospect of collecting anything, ever. Evidence includes the borrower's bankruptcy or insolvency, disappearance, a judgment you cannot collect, or documented failed collection efforts. A loan that is merely in default is not there yet; a loan where the borrower is judgment-proof and unresponsive after real attempts likely is. Partial worthlessness does not count for nonbusiness debts.

Can I deduct the interest I never received?

No. Your deduction is limited to your basis, meaning the principal you actually handed over and never got back. Interest you expected but never received was never reported as income, so there is nothing to deduct. The same logic bars deducting your own time or aggravation. Attorney fees spent on collection raise a separate question worth asking a tax professional.

How do I prove the loan was real and not a gift?

With the paper trail: a signed promissory note stating the amount, interest rate, and repayment schedule, records of the transfer, any payments received, and your collection attempts (demand letters, messages, small claims filings). Loans to family get particular scrutiny, because the IRS presumes intra-family transfers are gifts unless the documentation says otherwise.

When and how do I claim it?

In the tax year the debt becomes totally worthless, on Form 8949 (short-term section) flowing to Schedule D, with a statement describing the debt: who owed it, the amount, when it arose, and the efforts you made to collect. Claiming too early invites disallowance, and there are deadlines for amending, so the year of worthlessness is worth getting right, ideally with a tax professional.

Writing Off an Unpaid Promissory Note as a Bad Debt

The loan is dead. The borrower is bankrupt, vanished, or judgment-proof, and the money is not coming back. The consolation prize is a tax deduction, and it is a real one, but it is narrower than most lenders hope: capital loss treatment, principal only, and only in the year the debt truly dies. Here is how the write-off works and the documentation that makes it survive scrutiny.

What kind of deduction this is

For a private lender, an uncollectible loan is a nonbusiness bad debt. The IRS treats it as a short-term capital loss, regardless of how long the loan was outstanding. That classification drives everything: it goes on Form 8949 and Schedule D, it offsets capital gains dollar for dollar, and after that it can absorb up to $3,000 of ordinary income per year, with the excess carried forward. A $30,000 loss with no capital gains to offset can take a decade to fully use. Painful, but far better than nothing.

The worthlessness requirement

Nonbusiness bad debts are all or nothing: the debt must be totally worthless before you deduct anything, and partial worthlessness does not count. Worthless means no reasonable prospect of recovery, shown by facts like:

The borrower's bankruptcy discharge or clear insolvency
A judgment you obtained and cannot collect
The borrower's disappearance after documented attempts to locate them
Collection efforts that failed, in writing

A loan that is merely late is not worthless, and neither is one the borrower is still nibbling at with occasional payments. If you have not yet made a real collection attempt, that is the step before the write-off, both because you might recover and because the attempt is evidence. See when a borrower stops paying and small claims court for unpaid notes.

What you can and cannot deduct

Deductible: the principal you actually lent and never got back, reduced by anything repaid.
Not deductible: unpaid interest you never received. It was never reported as income, so there is no loss to claim.
Not deductible: money that was really a gift, no matter what anyone called it later.

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The bona fide loan test

This is where family lenders lose the deduction. The IRS presumes money handed to a relative is a gift, and it is your job to rebut that with evidence the transaction was a genuine loan: a signed promissory note with an interest rate and a repayment schedule, records of the transfer, payments received along the way, and demand letters when it soured. An undocumented handshake loan to a cousin looks exactly like a gift on audit, and gifts are not deductible. If you are reading this before the loan goes bad, the note itself is the fix; see lending money with nothing in writing. And if you intend to forgive a family loan rather than write it off, that is a different path with its own tax rules; see forgiving a family loan and gift tax.

Claiming it correctly

Fix the year the debt became totally worthless; that is the year you claim.
Report it in the short-term section of Form 8949, flowing to Schedule D.
Attach a statement describing the debt: the borrower, the relationship, the amount, when it arose, and the collection efforts made.
Keep the file: the note, transfer records, the payment ledger, demand letters, and any judgment. See keeping a payment ledger.
For a large loss, involve a tax professional, both for the worthlessness year and for anything unusual like collateral or partial recoveries.

If the money comes back later

Occasionally a written-off borrower resurfaces and pays. A recovery of a previously deducted bad debt is generally income in the year received, to the extent the earlier deduction produced a tax benefit. Take the money, report it, and enjoy the rare happy ending.

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