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I have a question on if I can deduct a debt that is not repaid on my taxes. We made a loan to FIL several years ago on which I have a Promissory Note. While he was still living, he made several payments against it, and I reported the interest paid on our taxes as required. However, he passed away 2 years ago, and we do not expect to get the remaining balance from his estate due to the Medicaid lien. Does that mean that I can deduct the remaining balance as a bad debt? If so, how do I report that?

We are hoping that his estate will be closed out this year, and so I will know that the debt is bad. If it goes until 2014, I'd be reporting it there instead, but I don't think that makes a difference in terms of my question.

I found some information on the IRS website about bad debts, but it talked about business loans, and this didn't feel like it fit in that category.

Do you need any additional information to answer my question?
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You might start here: http://www.irs.gov/taxtopics/tc453.html

George
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Thank you. It looks like I just need to wait until Probate is completed to prove that this is a bad debt.
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Conversely, does an unpaid loan (when proven not to be a gift) need to be reported as "income" for the party that did not honor payment of the debt/loan?

Just wondering.
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Conversely, does an unpaid loan (when proven not to be a gift) need to be reported as "income" for the party that did not honor payment of the debt/loan?

Probably. There have been many reports of the IRS dinging people for the "forgiven" part of a mortgage when they negotiate a short sale with their lender.
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Thank you. It looks like I just need to wait until Probate is completed to prove that this is a bad debt.

You should ask the Estate Executor for a letter acknowledging the debt and stating that there are no assets to repay it.

Ira
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You should ask the Estate Executor for a letter acknowledging the debt and stating that there are no assets to repay it.

DH is the Executor, so I will tell him to ask the attorney about how to document this. It should be pretty straightforward. The estate will end up bankrupt as there is not enough money to pay off the Medicaid lien, so there will be all the right sort of paper trail readily available.
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Did you file this debt as a claim against the estate? If not, do so now.

Donna
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Did you file this debt as a claim against the estate? If not, do so now.

No, but we have a written Promissory Note that the attorney has known about all along since he wrote the Promissory Note back in 2007. Do we still need to do something else with it? It's not like it will jump in front of the Medicaid lien, which already puts the estate in the hole by about $100k. My understanding is that Medicaid comes before everything else except final expenses (which we are also owed) and attorney's fees.

We have recently changed from the original attorney to a new attorney, and DH can ask him.

It is a very tangled estate, and is actually one of 3 that are in process, but they are intertwined. It is a really good lesson in why you shouldn't do DIY estate planning, and I'm really thankful that we've had our own estate plans in place since 1994 so my kids will never have to deal with anything remotely resembling this mess.
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