Taxpayers can generally deduct bona fide bad debts on their tax returns, in the year the debts become worthless.

One taxpayer in the lending business made a $100,000 loan to a furniture company. When that company failed in 2014, the assets were sold and the lender received $36,800. He claimed the loan balance as a bad debt on his 2014 tax return.

The IRS conceded the loan was bona fide, but disallowed the deduction, finding the loan wasn’t an ordinary part of the business and wasn’t incurred in 2014. The U.S. Tax Court disagreed and allowed the deduction. It arose as part of the taxpayer’s lending business and was properly claimed in the year the debt became worthless. (TC Memo 2019-118)