Some Caveats Before You Take a Tax Write-Off for Loan a Relative Didn’t Repay

Q: I made a $500 loan to my grandnephew, and the loan has not been repaid as agreed. Am I allowed to write off the note as a bad loan on my tax return? If so, where do I claim the deduction?

--A.J.R.

A: Although a $500 loan isn’t likely to arouse the suspicions of the Internal Revenue Service, let’s treat this as though a far larger sum were involved, just for the sake of example.

First, you have to be able to 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 parents and children--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 have required that the signatures be notarized.)

If you are not repaid by a borrower, 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 existence of a signed note with interest payment requirements.

What does this mean for you? Assuming you required your grandnephew to sign a note when you lent him the $500, you must attempt to collect on it. Even if your efforts are futile, you must document them and keep the records.

Once this is done, you can deduct your loss, which the IRS considers a “nonbusiness bad debt.” Such debts are generally defined as loans not connected with the lender’s primary business or occupation. As such, you would be 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.

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Q: I understand that a dividend is the amount some companies pay their shareholders every quarter. But what does it mean when a company goes “ex-dividend”?

--V.S.

A: Technically speaking, “ex-dividend” is a term that refers to a period of time during which the next dividend is not payable to those who buy the stock.

Here’s how it works:

Let’s say company XYZ pays dividends for the quarter ending March 31 to shareholders of record on March 10. This means that for the period between March 10 and the payment date of March 31, the shares are “without a dividend,” or “ex-dividend,” for that one quarter to investors who buy the shares in that time interval.

On the other hand, investors selling shares during the ex-dividend interval are still entitled to the March 31 quarter’s dividend because they were the owners of record on that date.

Practically speaking, shares actually turn ex-dividend two days before the official shareholder-of-record date because of the three-day settlement period required for trades to clear.

Stockbrokers and investors often like to buy just before an ex-dividend date to capture an additional payment. For example, if you buy shares the two days before an ex-dividend day and hold them for a year and one day, you should qualify for five dividend payments, not the four that holding shares for a year usually permits.

However, you should know that shares often increase in price as the ex-dividend date approaches, in part because investors are shopping for extra payments. Sometimes the increase in the share price is greater than the extra dividend is worth, so be careful. A stockbroker we know says he likes to start his ex-dividend shopping a few weeks before the actual ex-dividend date just to avoid the run-up.

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Q: I recently participated in a stock-for-stock exchange involving shares of Petrolite Corp. for Baker Hughes Corp. Does my cost of the exchanged stock, Petrolite, become the cost basis of the new shares of Baker Hughes that I received? If not, how do I determine the cost basis of the Baker Hughes?

--T.J.H.

A: Your supposition is correct. Your original cost basis in Petrolite becomes your cost basis of Baker Hughes. Of course, the per-share values will be different if you are receiving a different number of shares than you originally held. To arrive at the per-share cost basis of the new shares, divide the total cost basis of the old shares by the number of new shares you receive in the swap.

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Carla Lazzareschi will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail carla.lazzareschi@

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