Tax questions

March 21, 2000

Members of the Maryland Association of Certified Public Accountants are answering readers' tax questions through April 15.

I have a great aunt who borrowed some money from me several years ago, and never repaid any of it. I didn't get a note or anything signed by her, and she died, which makes the debt uncollectible. Is there any way I can deduct this from my income taxes?

Generally, if someone owes you money that you cannot collect, you may be able to deduct the loss in the year the debt became uncollectible, as a bad debt. There are two kinds of bad debts: business bad debts and nonbusiness bad debts. The rules determining how they are deducted on your return, and if any limitations apply, are different for each.

Generally, a business bad debt is one that comes from operating your trade or business and is deductible as a business loss. Nonbusiness bad debts would basically come from transactions other than within the operations of your trade or business.

Nonbusiness bad debts are deducted as short-term capital losses, no matter how long the holding period. The loan must be a genuine debt: There must be a debtor-creditor relationship based upon a valid and enforceable obligation to repay a fixed or determinable sum of money. Loans between family members are subject to strict scrutiny, and are basically presumed to be gifts, unless it can be shown that a debtor-creditor relationship exists.

Among some of the factors commonly considered include: the existence of a note or other written evidence; if interest is being charged; if a fixed payment schedule of principal and interest exists; whether any repayments were made or if there was a demand for repayment; and did the parties' records treat the transaction as a loan?

Based upon your specific question, did your aunt have a probate estate that was solvent? If so, you may be able to file a claim against the estate and collect payment with accrued interest (a normal creditor would do this). But your choosing not to collect payment when you could have helps demonstrate that no debtor-creditor relationship existed. Now, it looks more like a gift to your aunt, or to your aunt's estate.

Howard D. Jacobs, CPA, Pikesville

The above advice is for general purposes only and is not intended as legal, accounting or tax advice. Specific situations may vary.

Selected questions will be answered in the Business section. No questions will be answered personally.

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