If you had a tenant who did not pay rent, you cannot declare a loss for the unpaid rent unless and until you take formal legal action to get a judgment against her for the payment and you have taken adequate steps to attempt collection and it becomes bad debt. The security deposit that you kept will be reported as income.
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Generally, to deduct a bad debt, you must have previously included the amount in your income or loaned out your cash. If you're a cash method taxpayer (most individuals are), you generally can't take a bad debt deduction for unpaid salaries, wages, rents, fees, interests, dividends, and similar items. For a bad debt, you must show that at the time of the transaction you intended to make a loan and not a gift. If you lend money to a relative or friend with the understanding the relative or friend may not repay it, you must consider it as a gift and not as a loan, and you may not deduct it as a bad debt.
In other words-unpaid rent is unpaid rent no matter what you call it.
This is a rental business not personal income. The tax section you are referencing is for personal debts and loans. I didn't loan money. I incurred an unpaid expense when the tenant incurred costs greater than the deposit.
If your tenant damaged the living quarters and the repairs needed cost more than the security deposit, you can deduct the expenses that you paid that were greater than the security deposit on Schedule E.