Can I claim business bad debt deduction on my taxes this year for unpaid loan?

You're dealing with a challenging situation that many people face with business loans gone bad. The IRS does allow deductions for business bad debts, but there are specific requirements you need to meet. First, you need to establish that this was truly a business loan rather than a personal one, which sounds like you can do with your promissory note and documentation. Business bad debts are deducted as ordinary losses, while personal bad debts are treated as short-term capital losses with more limitations. For the debt to be deductible, you need to show it became "worthless" during the tax year you're claiming it. You don't necessarily need the company to declare bankruptcy, but you do need to demonstrate you've taken reasonable steps to collect and that there's no realistic expectation of repayment. Some ways to document worthlessness might include: correspondence showing the company admits inability to pay, evidence of the company selling major assets, documentation of failed collection attempts, or business financial statements showing insolvency. Since you've filed an extension to October 2024, you could potentially claim it this year if you can gather evidence of worthlessness before filing. Keep gathering documentation about their financial situation.

After reading about your situation, I had something similar happen last year with a business loan that went south. I spent weeks going in circles with the IRS website and getting different answers from every tax preparer I talked to. Finally tried https://taxr.ai where you can upload your loan docs and get a clear answer on deductibility. They analyzed my promissory note and demand letters and explained exactly what additional documentation I needed for my case. Their system reviewed a bunch of similar IRS cases and showed me how to properly document the debt as worthless without waiting for bankruptcy. Saved me a ton of time trying to interpret the tax code myself. Might be worth checking out since business bad debt rules are super specific.

Just wanted to update after trying taxr.ai for my own situation with business debt. Really surprised by how specific their guidance was. I uploaded my loan documentation and got back a detailed explanation of exactly what I was missing to prove worthlessness. They showed me similar IRS cases where taxpayers successfully claimed the deduction without having to wait for bankruptcy. The most helpful part was getting templates for documenting collection attempts and a checklist of evidence needed for my specific circumstances. Definitely more helpful than the generic advice I was getting elsewhere. Worth checking out if you're dealing with this kind of situation.

Something else to consider - have you tried calling the IRS directly to ask about your situation? I've been dealing with a slightly different bad debt issue and spent WEEKS trying to get through to someone who could actually help. I finally used https://claimyr.com to get through to an agent (you can see how it works at https://youtu.be/_kiP6q8DX5c) after being on hold for hours with no luck. Got connected to a specialist who walked me through exactly what documentation they look for in business bad debt cases during audits. Apparently they have specific guidelines for different industries and loan types. The agent confirmed I didn't need to wait for bankruptcy to claim the deduction as long as I had evidence of insolvency and reasonable collection attempts.

I have to eat crow and update my skeptical comment. After waiting on hold with the IRS for nearly 2 hours yesterday and getting disconnected, I broke down and tried Claimyr this morning. Got connected to an IRS agent in about 30 minutes who was actually knowledgeable about business bad debt. The agent explained that for my situation (similar to yours but with a contractor), I needed to document both my attempts to collect AND evidence the debt is uncollectible. She specifically mentioned that statements from collections agencies declining to take the case can serve as evidence, which I hadn't thought of before. Also recommended getting a credit report on the business to document their financial troubles. Definitely worth the call - I got specific actionable information rather than just referrals to publications.

One thing nobody's mentioned yet is that you might want to consider claiming this as a non-business bad debt if you can't fully document it as a business bad debt. Non-business bad debts are treated as short-term capital losses, which isn't as good as an ordinary business loss, but still better than nothing. For it to qualify as a business bad debt, you generally need to show you were in the business of lending money or that the loan was somehow related to your trade or business. If it was just a one-off loan, the IRS might challenge a business bad debt classification. I went through this last year with a similar amount and ended up going the non-business bad debt route because it was less documentation and less risk of audit.

Don't forget the timing issue - the bad debt deduction must be taken in the year the debt actually becomes worthless, not when you decide to write it off. If you have evidence it became worthless in 2023, you should take it then. If it's becoming worthless in 2024, take it this year. Taking it in the wrong year is a common mistake and the IRS can disallow the deduction even if you have all the right documentation. Since you filed an extension for 2024 taxes (due Oct 2024), you need to determine if the worthlessness occurred in this tax year.