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Treatment of Non-Business Bad Debt and Recovery Thereof

Sue loaned her friend john $15K four years ago. John signed a note and made payments on the loan. Last year, when the remaining balance of the loan was $8K. John filed bankruptcy and notified Sue that he would be unable to repay the $8K balance remaining on the loan. Sue treated the $8k as a bad debt. Last year Sue had net long-term capital gains of $1K and taxable income of $41K. Sue did not itemize her deductions last year. During the current year, John paid Sue $5K in satisfaction of the debt. Determine Sue's tax treatment for the $5000 received in the current year.

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Treas. Reg. 1.166-5(2) states that " If, in the case of a taxpayer other than a corporation, a non business debt becomes wholly worthless within the taxable year, the loss resulting there from shall be treated as a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year (6 months for taxable years beginning before 1977; 9 months for taxable years beginning in 1977). Such a loss is subject to the limitations provided in section 1211, relating to the limitation on capital losses, and section 1212, relating to the capital loss carryover, and in the regulations under those sections. A loss on a non business debt shall be treated as sustained only if and when the debt has become totally ...

Solution Summary

Citing relevant sections of the Internal Revenue Code, this solution discusses the tax treatment of a non-business bad debt and of the amount recovered after deducting the debt.