You can write off a loan to a friend as a bad debt on your federal taxes, but only if it was a real loan rather than a gift, only if it’s now completely uncollectible, and only within limits. The IRS treats a worthless personal loan as a nonbusiness bad debt, which becomes a short-term capital loss on your return. That loss first cancels out any capital gains you had for the year, then reduces up to $3,000 of your other income ($1,500 if you’re married filing separately). Anything left over carries forward to future years.1Office of the Law Revision Counsel. 26 USC 166 – Bad Debts2Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
When the IRS Considers a Personal Loan a Real Debt
The deduction lives or dies on whether the transfer was a bona fide debt. Federal regulations define that as a debtor-creditor relationship built on a valid and enforceable obligation to pay a fixed sum of money. Gifts are specifically excluded, no matter how the parties describe them.3GovInfo. 26 CFR 1.166-1 – Bad Debts
The cleanest proof is a signed promissory note showing the amount, an interest rate, a repayment schedule, and a maturity date. It doesn’t have to be notarized. Without something in writing, you’re arguing intent from bank records and texts, and auditors tend to be skeptical of that, especially when the borrower is a friend or relative. The IRS often treats transfers between people who know each other well as gifts unless the lender can show real enforcement intent: interest charged, deadlines set, follow-ups on missed payments.
There’s a second requirement people miss. To have a bad debt at all, you need a tax basis in the debt, and for a cash-basis taxpayer that means you actually loaned out your own money.4Internal Revenue Service. Topic No. 453, Bad Debt Deduction Unpaid wages, unpaid rent, or fees a client never sent don’t qualify, because you never reported that money as income in the first place. Only real dollars that left your bank account can be written off.
Proving the Loan Is Worthless
A nonbusiness bad debt is all or nothing. Unlike a business bad debt, you can’t take a partial deduction — the debt has to be completely worthless, with no reasonable expectation of ever collecting a dollar.4Internal Revenue Service. Topic No. 453, Bad Debt Deduction
You need to show you tried to collect. Demand letters, phone calls, emails, or formal notices all count. You do not have to sue. The IRS accepts that filing a lawsuit makes no sense when the borrower has nothing to seize, and it says outright that court action isn’t required if a judgment would be uncollectible anyway.4Internal Revenue Service. Topic No. 453, Bad Debt Deduction
Good evidence of worthlessness includes the borrower’s bankruptcy filing, a lack of seizable assets, prolonged unemployment, or overwhelming medical debt. Timing matters: you must claim the deduction in the year the debt actually became worthless. If it went bad in 2025 and you don’t realize it until 2027, you file an amended 2025 return rather than deducting it on the current year’s taxes.
How to Report the Bad Debt on Your Return
Reporting takes three pieces working together: a written bad debt statement, Form 8949, and Schedule D.
The bad debt statement attaches to your return and must cover four things:4Internal Revenue Service. Topic No. 453, Bad Debt Deduction
- A description of the debt, including the amount and the date it came due
- The borrower’s name and your relationship to them
- The collection efforts you made
- Why you believe the debt will never be repaid
On Form 8949, the bad debt goes in Part I as a short-term transaction. Check box C at the top, since there’s no Form 1099-B for a personal loan. In column (a), enter the borrower’s name and note “bad debt statement attached.” Put zero in the proceeds column and your original loan amount as the cost basis.5Internal Revenue Service. Publication 550 – Investment Income and Expenses The loss flows from Form 8949 onto Schedule D, where it nets against your other capital gains and losses for the year.6Internal Revenue Service. Instructions for Form 8949
The $3,000 Cap and What Happens to the Rest
Because the deduction is a short-term capital loss, it faces the general capital-loss limits. After it offsets your capital gains, only $3,000 of what’s left can reduce your ordinary income in a single year, or $1,500 if you file separately from your spouse.2Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
The rest doesn’t disappear. It carries forward as a short-term capital loss into the next tax year, and the year after that, until you’ve used all of it.7Office of the Law Revision Counsel. 26 USC 1212 – Capital Loss Carrybacks and Carryovers There’s no expiration. Lend a friend $15,000 with no capital gains to soak it up, and you’d take $3,000 a year for five years to fully deduct the loss.
Records to Keep, and for How Long
Most tax records only need to stick around for three years. Bad debt deductions are the exception: keep the supporting records for seven years from the due date of the return where you claimed the loss.8Internal Revenue Service. How Long Should I Keep Records That matches the seven-year statute of limitations for filing a refund claim tied to a bad debt, which is longer than the usual three-year window.9Internal Revenue Service. Time You Can Claim a Credit or Refund
Hold onto the promissory note, bank statements showing the money went out, every piece of collection correspondence, and anything documenting the borrower’s inability to pay. If you’re carrying the loss forward across several returns, keep everything until seven years after the last return that used it. The same seven-year window works in your favor if you realize you missed the deduction in a prior year: you can file an amended return and still capture it.
If the IRS Calls It a Gift Instead
One boundary worth knowing. If the IRS looks at your transfer and decides it was a gift rather than a loan — no written agreement, no interest, no collection efforts — the bad debt deduction is gone, and gift tax rules take over instead. For 2026, transfers up to $19,000 per recipient per year fall under the annual exclusion and require no filing. Above that, you’d need to file Form 709, which usually doesn’t create a tax bill but does chip away at your lifetime exemption.10Internal Revenue Service. Whats New – Estate and Gift Tax The way to avoid this is documentation on the front end: a written note, a stated interest rate, and evidence that you treated the arrangement like a loan while it was outstanding.