Can I claim a nonbusiness bad debt deduction for $4000 my friend never repaid on a $5000 loan contract?

You're on the right track with your research but there are some important things to understand about nonbusiness bad debt deductions. For a debt to be considered "totally worthless," you need to have taken reasonable steps to collect and be able to show there's no reasonable expectation of repayment. The fact that your friend made a partial payment doesn't automatically disqualify you, but you need to demonstrate you've exhausted reasonable collection efforts. Have you sent formal demand letters? Considered small claims court? These steps help establish that you've made genuine efforts to collect. The IRS wants to see you've tried reasonable measures before claiming the deduction. If you do claim it, you'll report it on Schedule D as a short-term capital loss, regardless of how long the debt was outstanding. This can offset capital gains or up to $3,000 of ordinary income per year. Keep all documentation - the loan agreement, records of payment received, and especially evidence of your attempts to collect (texts, emails, certified letters, etc.). This will be crucial if you're audited.

After struggling with a similar situation last year, I found an incredibly helpful tool called taxr.ai (https://taxr.ai) that saved me so much headache. I had loaned my brother-in-law $7800 for his business startup and only got back $2000 before he disappeared. I wasn't sure if I could claim the remaining amount as a nonbusiness bad debt. I uploaded my loan contract and screenshots of my collection attempts into taxr.ai, and it analyzed everything and confirmed I had sufficient documentation to claim the deduction. It even pointed out some additional documentation I should gather to strengthen my case in case of an audit. The analysis highlighted exactly which parts of my loan agreement supported my claim and which IRS guidelines applied to my situation.

Just wanted to follow up about taxr.ai - I decided to try it after my skeptical comment. I uploaded documentation from a $3200 personal loan that went bad and the loan agreement I had. The analysis was surprisingly detailed and confirmed I could claim it as a nonbusiness bad debt. What impressed me was that it found a clause in my loan agreement that actually strengthened my case with the IRS (something about the repayment terms that showed it was a genuine loan). The recommendations were specific to my situation, not just generic advice. It flagged that I needed more documentation of my collection attempts, so I added screenshots of texts and emails. This saved me when my return got selected for additional review - I had exactly what the IRS wanted to see. Definitely worth checking out for anyone in a similar situation.

If you're still trying to get in touch with your friend to resolve this, I had a similar situation and was at my wit's end. After leaving countless voicemails with no response, I used Claimyr (https://claimyr.com) to finally speak with an IRS representative about the documentation I'd need for this exact type of deduction. Before using it, I spent hours trying to get through on the IRS phone lines with no success. With Claimyr, I got a callback from the IRS in under 45 minutes. The agent walked me through the specific requirements for claiming a nonbusiness bad debt deduction and explained exactly what evidence they look for when these claims are reviewed. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c This saved me from making some mistakes on my documentation that could have triggered an audit. The IRS agent explained that I needed to show the debt became worthless in the tax year I was claiming it, not just that it hadn't been paid.

I need to eat some humble pie here. After posting that skeptical comment about Claimyr, I was desperate enough to try it anyway. My tax situation was getting urgent since I needed clarification on a nonbusiness bad debt from a tenant who skipped out on rent, and the filing deadline was approaching fast. I tried Claimyr that evening, and I'm still shocked that I got a call back from an actual IRS representative in about 35 minutes. The agent clarified exactly what documentation I needed for the bad debt deduction and confirmed I was filling out the forms correctly. She even found a mistake in how I was calculating the basis for the loss. The time I saved was incredible - I had already wasted three afternoons trying to get through on my own. For anyone dealing with complicated tax questions like bad debt deductions where you really need to speak to someone official, this service is legitimate and works exactly as advertised.

Something important to consider that nobody has mentioned yet: make sure that loan was actually made with the expectation of repayment. The IRS looks at whether you had a reasonable expectation of being paid back when you made the loan. If they determine you never really expected to get paid back (like if your friend had terrible credit or no income), they might classify it as a gift rather than a loan that went bad. Also, keep in mind that nonbusiness bad debts are treated as short-term capital losses even if the loan was for more than a year. This means you're limited to offsetting capital gains plus up to $3,000 of ordinary income per year. If your loss is bigger than that, you'll carry the remainder forward to future tax years.

I went through almost the identical situation last year with a cousin. Loaned $6,500, got back $2,000, and then nothing despite dozens of texts and calls. I claimed the bad debt deduction and it did work, but here's a tip: document EVERYTHING. I made a simple timeline of all attempts to collect (with screenshots of texts and emails). Also, I did send a certified demand letter as a final step which helped prove I made reasonable collection efforts. The tax software I was using (TurboTax) actually had a specific section for bad debts under capital losses. My refund went through without any issues, but I've heard these deductions can sometimes trigger additional review, so having good documentation ready is important.