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How to deduct personal bad debts

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in Small Business Tax

Q: My brother borrowed $20,000 from me back in 2000. We set up a payment plan with 7 percent interest payments. But he only paid back $2,700 before he died last year without any real assets. Can I deduct the unpaid balance on my 2003 return? K.R., Newburgh, N.Y.

A: Yes. You must deduct a personal "bad debt" as a short-term capital loss. So that loss can be used to offset capital gains that you realized in 2003, plus up to $3,000 of ordinary income. Any excess loss may be carried over. The IRS may want to see proof of the legitimacy of the loan, so hold on to the relevant records of your arrangement.

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