Any amount of money that your IRA may loan to an individual or business and do not receive back qualifies as an un-collectible debt because it was once included in your income. When you write off a bad loan in your Roth IRA you may be able to recover some tax deduction, however in a traditional IRA it is less likely you will recover any tax deduction because you never paid tax on the loaned money..

  1. Make a copy of the original loan agreement between yourself and the debtor. You must demonstrate to the IRS that you fully expected the debtor to repay the amount borrowed.
  2. Make copies of any proof that demonstrates that the debt is worthless. Although proof is not required, it supports your claim that the debt was once valid. An example of proof is a certified copy of a court judgment against the debtor for the unpaid loan balance.
  3. Subtract any funds the debtor has already paid you from the total amount you originally loaned him. The resulting number is the amount of your bad debt deduction.
  4. Write a statement to the IRS that includes any details about the loan that were not included in the original loan contract. If you do not have written proof that the loan debt is worthless, you may use the letter to notify the IRS of the reasons why you believe the loan is uncollectible.
  5. Send the debtor and IRS a Form 1099-C, Cancellation of Income form, if the loan balance totals $600 or more. Once the debtor receives the Form 1099-C, debtor must include the unpaid balance of the loan in the debtor’s annual income when debtor files the annual tax return.

The IRS then assumes the responsibility of collecting the remainder of the loan and or tax from the debtor.

Provide this information to your administrator/custodian and your asset should be re-valued or removed from the account.

  • You do not have to wait until the debt becomes worthless to claim it as worthless. If you have a legitimate reason to believe that the debtor will not be able to make payments on the debt, such as if the debtor files for bankruptcy, is convicted of a felony, you may assume the debt is worthless and claim it as uncollectible debt. Verify with a tax professional to determine the extent of possible tax deductions.

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