Just like businesses, loans by their very nature carry an element of risk. What happens when that friend or family member never get to that “better place” or due to unforeseen circumstances, they choose not to repay the loan? These non-business bad debts can be deductible on your individual tax return in the year that it’s determined that there is no chance that the loan will be paid back (i.e. death, disability, written notice).
While we would hope that loans to friends and family would be repaid as originally agreed, we’d like to provide some tips to substantiate your deduction if the need should arise:
- Intent: If you lend money to a friend or relative without the intent to be repaid, it’s considered a gift and not a loan. Both parties need to agree that this is a loan with the intent to repay it at some future date.
- Documentation: Loans should be documented in writing and preferably signed by both parties. The documentation should include: date of loan, amount of loan, terms of repayment and interest rate (if any).
- Follow Up: When the term of the loan is up, there needs to be some sort of attempt to collect payment from the debtor. Documentation of phone calls, e-mails or correspondence should be kept on file along with any responses from the debtor regarding their ability or intent to repay the loan.