Are uncollectible loans deductible?

[rjmeyer315]

Invested in a startup distillery by buying stock shares and making loans.  The business closed, shares are worthless and no payments were made on the loans.  I believe the stock shares are deducted as capital losses.  Are the defaulted loans capital losses too?  Thanks.

[MichaelMc · Accepted solution]

You are correct that the worthless shares can be deducted as a capital loss. You must be able to show, if the IRS inquires, that the company has legally dissolved or that the shares are totally worthless by some independent measure.

Your ability to deduct the defaulted loan depends on the context in which the loan was made. If you were extending credit to the startup personally, that is, you are not in the business of making loans or in some other business relationship with the borrower, the loan is a non-business bad debt and must be totally worthless for you to take a tax deduction.

If you operate a business that was investing in the distillery, or are a supplier who made the loan to the distillery in hope that it would prosper and become an even larger customer for your goods, then it would be a business bad debt. Business bad debts can be deducted if they are wholly or partially worthless.

Please refer to the linked IRS Tax Topic for more information: https://www.irs.gov/taxtopics/tc453