Question

In 2014 Grace loaned her friend Paula $12,000 to invest in various stocks. Paula signed a note to repay the principal with interest. Unfortunately the market for that industry sector plunged, and Paula incurred large losses. In 2015 Paula declared personal bankruptcy and Grace was unable to collect any of her loan. Grace had no other gains or losses last year or this year. The result is

A) Grace deducts a business bad debt of $3,000 in 2015 and carries $9,000 over to subsequent years.
B) Grace deducts a business bad debt of $12,000 in 2015
C) Grace deducts a $3,000 nonbusiness bad debt as a short-term capital loss in 2015 and carries $9,000 over to subsequent years.
D) Grace deducts a $12,000 nonbusiness bad debt as a short-term capital loss in 2015.

Answer 1

Grace can deduct the $3,000 nonbusiness bad debt as a short-term capital loss in 2015 and carry the remaining $9,000 over to subsequent years.

Step-by-step explanation:

In the scenario described, Grace has provided a loan to Paula which has been lost due to Paula's bankruptcy. Since the loan was a personal transaction and not related to Grace's business, it is classified as a nonbusiness bad debt. Nonbusiness bad debts are treated as short-term capital losses, regardless of the actual duration of the loan. According to the tax regulations, a short-term capital loss can be used to offset any capital gains. If there are no gains, an individual can deduct up to $3,000 per year against ordinary income and the remaining loss can be carried over to subsequent years.

In this case, because Grace has no other gains or losses, she can deduct $3,000 in 2015. The remaining $9,000 becomes a capital loss carryover that Grace can use in future years.