Tim loaned a friend $4,000 to buy a used car. In the current year, Tim's friend declares bankruptcy and the debt is considered totally worthless. What amount may Tim deduct on his individual income tax return for the current year as a result of the worthless debt, assuming he has no other capital gains or losses for the year?
A)$4,000 ordinary loss
B)$4,000 short-term capital loss
C)$2,000 short-term capital loss
D)$3,000 ordinary loss
E)$3,000 short-term capital loss

Question

Quizplus · Accepted Answer

When a personal loan to a friend becomes totally worthless, it is treated as a nonbusiness bad debt for tax purposes. Nonbusiness bad debts are reported as short-term capital losses regardless of how long the loan was outstanding. The maximum amount of capital losses that can be deducted against ordinary income in any one year is $3,000 ($1,500 if married filing separately). Therefore, Tim may deduct $3,000 as a short-term capital loss on his individual income tax return for the current year.

Tim Loaned a Friend $4,000 to Buy a Used Car