"Neither a borrower nor a lender be, for loan oft loses both itself and friend." William Shakespeare
Well what can you do if you have ignored Shakespeare's good advice and lent money to a friend who won't or can't pay you back. The IRS lets you take a short term capital loss on your tax return if the loss meets certain qualifications. It has to be a legal obligation meaning a written document signed by both parties, and the loan has to be totally worthless not just partially worthless. Loans to relatives face much greater scrutiny by the IRS and should in most cases just be considered gifts and not deductible bad debts. You have to attach a statement to your tax return indicating the following: description of the debt, amount, and date due, debtor's name and relationship, efforts made to collect debt, and why you think it is worthless. Vigorous documented efforts to collect the debt and a letter from the debtor explaining why he can't repay are good ways to support your deduction.
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