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Bad debts: Bankruptcy and loans

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In 2010, Grace loaned her friend Paula $12,000 to invest in various stocks. Paula signed a note to repay the principal with interest. This past year, the stock market plunged, and Paula incurred large losses. In 2012, Paula declared personal bankruptcy and Grace was unable to collect any of her loan. Grace had no other gains or losses last year or this year. The result is:

A. Grace deducts a business bad debt of $12,000 in 2012.
B. Grace deducts a $12,000 nonbusiness bad debt as a short-term capital loss in 2012.
C. Grace deducts a $3,000 nonbusiness bad debt as a short-term capital loss in 2012 and carries $9,000 over to subsequent years.
D. Grace deducts a business bad debt of $3,000 in 2012 and carries $9,000 over to subsequent years.

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Solution Preview

C. Grace deducts a $3,000 nonbusiness bad debt as a short-term capital loss in 2012 and carries $9,000 over to subsequent years.

The concept is correct, but we don't have any indication in this scenario that this was a business agreement. Grace ...

Solution Summary

This solution provides the correct answer with explanation to the bankruptcy and loans tax question presented. The applicable tax law is cited, and the proper deduction amount that Grace can take is thoroughly explained.

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