Documenting Terms of a Loan to Relatives Makes Claiming a Tax Deduction Easier
Q. I am one of the stupid people who have lent large sums of money to relatives only to find that it cannot be repaid. In 1990, I lent my brother and his wife $60,000, which was supposed to be used to repay some of their debts and make a down payment on a home. They stopped repaying me in 1991 and lost the house to foreclosure in 1993. I know they don’t have any money to repay me. May I deduct the remaining principal and unpaid interest on my taxes?
--S.L.
*
A. You cannot deduct any unpaid interest on the loan because the Internal Revenue Service does not allow taxpayers a deduction for losing money they never had. However, you should be able to deduct the unpaid portion of the $60,000 loan if you can demonstrate that the transaction was actually a loan, not a gift, and that you have made efforts to collect on it.
Not surprisingly, the IRS tends to be suspicious when taxpayers turn to the government for relief after a financial deal between family members sours.
In fact, it makes the presumption that loans to relatives, especially to children and parents, are gifts. To overcome this presumption, you should have taken some of the same steps you would have had you been making a business loan. For starters, you should have drafted a note outlining the terms of the loan, any collateral offered by the borrower and the details of the repayment schedule. The note should have been signed by all parties. (To be extra safe, you could even have required that the signatures be notarized.)
If a borrower fails to repay, you must make an effort to collect on the loan according to the terms of the note. Failure to enforce collection is typically viewed by the IRS as evidence that the deal was a gift, despite the signing of a note with interest payment requirements.
What does this mean for you? Let’s hope you drafted a note at the time you lent your brother the $60,000. Now you must attempt to collect on it. Even if your efforts are futile, you must document them and keep the records.
This done, you can begin to deduct your loss, which the IRS considers a “nonbusiness bad debt.” As such, you are entitled to treat it as a short-term capital loss, which you show on Schedule D of your tax return. You may offset the debt against any capital gains you have plus up to $3,000 of ordinary income each year. Any excess may be carried over to future years and deducted in the same manner until the entire amount has been accounted for.
You Are Entitled to 1 Social Security Check
Q. I am confused about an item you printed in a column earlier this month on Social Security payments for spouses, ex-spouses and widows. Are spousal Social Security benefits paid in addition to one’s own Social Security benefits or in lieu of them? In other words, can I get my own benefits as well as 50% of my husband’s?
--A.K.
*
A. You are entitled either to your own benefits or those as a spouse, whichever are greater. You are not entitled to both.
The amount you actually receive will be determined at the time you apply for your benefits.
For more information about spousal benefits, order the Social Security Administration’s free “Survivor’s Benefits” pamphlet by calling (800) 772-1213. Other pertinent pamphlets include “Understanding Social Security” and “Social Security, How It Works for You.”
Out-of-State Income Must Be Reported Twice
Q. I live in California and file state income taxes. I have investment property in Arizona that generates rental income. Must I file Arizona state income taxes to report that income?
--P.N.
*
A. You must file an Arizona state income tax return, reporting that income and paying the required taxes. You must also report the income on your California return. To avoid double taxation on the income, the California tax return should note the payment of state taxes in Arizona.
Carla Lazzareschi cannot answer inquiries individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Editorial, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. Or send e-mail to carla.lazzareschi@latimes.com
