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I have a question in preparation for next year's taxes. We had loaned FIL money years ago, some of which was able to be paid back. I do have a signed promissory note, and I have tracked interest and payments over the years, claiming the interest on my taxes in the years that payments were made.

FIL passed away, and so the remainder of the debt is no longer collectible because there are not enough assets in the estate. In fact, there are not enough assets to pay back Medicaid, so the estate is clearly bankrupt.

I am thinking that I should be able to deduct the balance of the debt when I file my 2014 taxes as a bad debt. In reading Topic 453 on the IRS website, I'm wondering what they mean by this phrase:

All other bad debts are nonbusiness. Nonbusiness bad debts must be totally worthless to be deductible. You cannot deduct a partially worthless nonbusiness bad debt.

What is a partially worthless bad debt, and does it affect me at all? Since there were some payments made, does that make this only partially worthless since it is only the balance that is unpaid? This is confusing me.

Also, I am thinking that the records I will need to keep for this will be the promissory note, the schedule of payments, the letter detailing the estate assets and liabilities, and the letter from Medicaid with their lien paperwork. Anything else that I'd need to keep?

I figure since we're doing all of this now, I'd prefer to make my notes and gather the paperwork together for next year so that I don't forget it and am not scrambling to find it.

Thanks for any help on clarifying this for me.
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All other bad debts are nonbusiness. Nonbusiness bad debts must be totally worthless to be deductible. You cannot deduct a partially worthless nonbusiness bad debt.

What is a partially worthless bad debt, and does it affect me at all? Since there were some payments made, does that make this only partially worthless since it is only the balance that is unpaid? This is confusing me.


My condolences on your loss. A partially worthless bad debt is one where you still may be able to collect something. For instance, if your FIL's estate were large enough to pay off Medicare, but not fully pay you back, you would have a partially worthless bad debt. "Partially" doesn't refer to the amount of initial indebtedness, but the amount of debt at a specific point in time. In your case, whatever part of the loan is currently outstanding is totally worthless as you have no chance of recovering any part of what's owed you.

If, for example, you expected to receive $1000 against the outstanding debt, you would not be able to write off the bad debt until after you recevied the $1000. At that point, the remaining balance would be totally worthless.

I hope this helps explain things.

Ira
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If, for example, you expected to receive $1000 against the outstanding debt, you would not be able to write off the bad debt until after you recevied the $1000. At that point, the remaining balance would be totally worthless.


Thank you. This is perfect, and I understand it now. We are in the process of closing out the entire estate, and so once all the checks are distributed, which will happen this week, the remaining balance will be outstanding, and so that is the number that will be our bad debt.

We weren't sure if anything would be able to be paid on the note given the Medicaid lien, and so we did wait until the very end of the process to see how it would turn out, though we knew the estate was bankrupt. We still had a chance to work with Medicaid to actually allow some of the note to be paid back, and so we have worked through that process at this point, and just received the official letter from Medicaid saying that the estate assets could be distributed, and how much goes to them.

There's an order to how things are paid, and the promissory note was in a bit of a gray area. Now, we do have the final numbers and so I can get all my paperwork in order.

Thanks so much for the quick clarification.
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