Can I deduct a personal loan I gave to my brother on my taxes?

Unfortunately, personal loans to family members are very difficult to write off as bad debts on your taxes. The IRS looks at these situations carefully because they know families often try to disguise gifts as "loans gone bad." For a bad debt deduction, you need to prove it was a genuine loan (not a gift), that you tried to collect the debt, and that the debt became worthless during the tax year you're claiming it. You'd need formal loan documentation, evidence of collection attempts, and proof it's now worthless - meaning you have no reasonable expectation of being repaid. Also, personal bad debts are claimed as short-term capital losses on Schedule D, not as direct deductions. This means they first offset capital gains, then can offset up to $3,000 of ordinary income per year.

I was in a similar situation last year with a loan to my sister that went south. I spent hours searching for answers and was going in circles until I found taxr.ai (https://taxr.ai). It was seriously a game changer for figuring out my bad debt situation. I uploaded our text message "agreement" and explained the situation, and it analyzed everything and told me exactly what documentation I needed for a legitimate bad debt deduction. More importantly, it showed me why my situation wouldn't qualify as deductible and saved me from potentially triggering an audit. They have a specific tool that evaluates personal loans vs business bad debts that really cleared things up.

Following up about taxr.ai - I actually tried it after my last post and wow. I uploaded screenshots of the Venmo payments to my friend for the food truck and our text convos. The analysis showed me EXACTLY why my loan wouldn't qualify as a bad debt (mainly because I couldn't prove it wasn't a gift). But the real value was it showed me how to document things properly for future situations AND gave me other options for my current situation. Saved me from claiming something that would've definitely triggered an audit. Worth every penny just for the peace of mind.

Speaking of audits, if you do decide to claim this as a bad debt and get audited, you'll end up needing to talk to the IRS. Good luck with that! I spent THREE WEEKS trying to get through to someone about a similar issue last year. Finally found Claimyr (https://claimyr.com) which basically holds your place in the IRS phone queue and calls you when an agent is about to answer. You can see how it works here: https://youtu.be/_kiP6q8DX5c Was super skeptical at first but it actually worked - got through to someone in about 45 minutes instead of waiting on hold for hours or getting disconnected. The agent I spoke with actually gave me some useful advice about documenting bad debts properly.

I need to eat my words about Claimyr. After posting that skeptical comment, I was desperate about my refund issue and decided to try it anyway. Holy crap it actually worked. Got a call back in about 2 hours, and talked to a real IRS person who resolved my refund issue in minutes. All those hours I wasted trying to call myself... I'm still mad about it. For anyone dealing with the bad debt issue in this thread - if you do need to talk to the IRS about it (which you probably will), save yourself the headache. I've been telling everyone I know who has tax issues about this service.

Just to add some more info on bad debt deductions - my tax guy told me there's a big difference between business bad debts and nonbusiness bad debts. If you loaned money to your brother FOR his business, and you're in the business of lending money, that could be a business bad debt which has better tax treatment. But if you just personally loaned him money, even if he used it for his business, it's probably a nonbusiness bad debt for you.

Has anyone tried claiming these types of loans as gifts instead? If you're below the annual gift tax exclusion amount (which is $18,000 for 2025), wouldn't it be easier to just consider it a gift for tax purposes? You wouldn't get a deduction but at least you wouldn't risk an audit, right?

I went through something similar with my sister a few years back. One thing that really helped me understand the situation was documenting everything I could find - not just for potential tax purposes, but to get clarity on what I actually had. Even though your original agreement was just text messages, gather everything you can: the initial texts about the loan terms, any payment records (bank transfers, checks, etc.), and any subsequent communications about repayment. If your brother acknowledged the debt in writing at any point, that's valuable too. The reality is that most personal loans to family members don't qualify for bad debt deductions because the IRS assumes they're really gifts unless you can prove otherwise. But having good documentation helps you understand where you stand and what your options are. You might also want to consider having a frank conversation with your brother about officially writing off the remaining balance - sometimes that's better for family relationships than dragging it out indefinitely. Whatever you decide, don't claim the deduction unless you're confident you can back it up with solid documentation. The last thing you want is an audit over a questionable deduction.