@Bsch4477 wrote:
My view is that this is not a bad debt but a loss related to improvement in personal property which is not deductible but could be added to the cost basis of the home. I am assuming that this is a personal residence.
But that's what a non-business bad debt is. Quoting publication 550,
Insolvency of contractor.
You can take a bad debt deduction for the amount you deposit with a contractor if the contractor becomes insolvent and you are unable to recover your deposit. If the deposit is for work unrelated to your trade or business, it is a nonbusiness bad debt deduction.
(page 84 https://www.irs.gov/pub/irs-pdf/p550.pdf)
Now, the amount may be tricky to determine. If you paid a $50,000 deposit and part of the work was done, and you had to pay someone else to finish, your loss probably isn't the whole amount. And your loss can't be more than you paid in -- suppose you paid $50,000 as the whole price of the job, and the work was so bad the next contractor had to tear it all out and start over so that the final cost was $70,000, your bad debt loss is only $50,000. (You could probably sue contractor #1 for the full $70,000, but if we are talking about a non-business bad debt discussion then we must already assume the business is worthless and the debt is non-collectible.) And you can't deduct personal legal expenses, if you paid a $50,000 deposit and then paid an extra $5000 to be represented at the bankruptcy proceedings, your deductible loss is only $50,000 and you can't recover legal fees.
But the basic case of paying a contractor to work on your home and they go bankrupt before it is completed is definitely a non-business bad debt.
