Question

Lana loans $ 2,000 to her widowed mother for an operation. Lana's mother owns no property and is not employed, and her only income consists of Social Security benefits. No note is issued for the loan, no provision for interest is made, and no repayment date is mentioned. In the current year, Lana's mother dies, leaving no estate. Assuming that the loan is not repaid, can Lana take a deduction for a nonbusiness bad debt?

Answer 1

Lana may qualify for a nonbusiness bad debt deduction for the loan she made to her mother when deemed completely worthless, but proving it as a bona fide debt for tax purposes might be difficult without documentation.

Step-by-step explanation:

According to U.S. tax law, Lana may be able to claim a deduction for a nonbusiness bad debt if certain conditions are met. To claim such a deduction, the debt must be considered completely worthless, which seems to be the case given that Lana's mother left no estate and there is no reasonable expectation of repayment. Normally, such debts are claimed as short-term capital losses on the tax return. However, without a promissory note or proof that the loan was intended as an enforceable obligation to repay, it may be difficult for Lana to substantiate the debt as a bona fide loan for IRS purposes.

Essentially, when a loan defaults, and no repayment can be expected, it's similar to what happens in a banking context when a bank has to assume a certain level of risk for non-repayment of loans. In a personal scenario like Lana's, her ability to deduct this as a loss relies on proving the loan's legitimacy as a debt and establishing its worthlessness.