Contractor Bankruptcy - Deduct as Nonbusiness Bad Debt

[kpankpow]

Hired a contractor to complete work at my personal house, and long story short, the contractor filed bankruptcy which left me out a sum of money for the uncompleted work. In doing some research, it appears I may be able to deduct this loss as nonbusiness bad debt via Form 8949. The bankruptcy was just recently closed out in February 2025. A few questions:

1. Am I correct in that I can deduct as nonbusiness bad debt?

2. Do I take the bad debt deduction in my 2024 return (current filing) or next years (2025), since the debt became officially worthless in 2025?

3. Am I limited to the $3000 capital loss deduction per year? And if so, do I deduct $3000 each year going forward until it's all accounted for? 

Thanks for any assistance.

[DaveF1006]

No, you would not be able to classify this as a non-business bad debt because these generally apply to personal loans or debts that individual lend to others, which become uncollectible.  In this case, you didn't lend anything but instead, entered into a contract which is not a debt instrument. 

Since, you entered into a contract, you experienced is a breach of contract. Since the contractor claimed bankruptcy, you may not have grounds for legal action but you may wish to consult with a legal professional to discuss possible remedies.

[kpankpow]

Thanks for the response. I dug into it more, and found that in IRS Publication 550 there's a section for "insolvency of contractor" and it states that it can be deducted as non-business bad debt. To clarify my situation, the contractor was paid in advance for tasks, which I'd consider a deposit, and when they filed bankruptcy, we were not able to recover the deposit. Does any of this change your interpretation?

[kpankpow]

Following up on this. Any additional insight would be appreciated

[JamesG1]

The example on page 85 appears to be the same as your situation.  You may claim the nonbusiness bad debt deduction as explained in this TurboTax Help.

To enter the form manually In TurboTax Premium Online, follow these steps:

1. Down the left side of the screen, click Federal.
2. Down the left side of the screen, click Wages & Income.
3. Click the down arrow to the right of Investments and Savings.
4. Click to the right of Stocks, Cryptocurrency, Mutual Funds, Bonds, Other (1099-B).
5. Click Add investments.
6. On the Let's import your tax info screen, select Enter a different way.
7. On the OK, let's start with one investment type screen, select Other, then Continue.
8. At the screen Tell us more, enter the information.  Include the term 'worthless'.  Click Continue.
9. On the screen Now, enter one sale, enter the information.
10. What type of investment, select Other.
11. How did you receive it, select Something else.
12. Enter the the term 'worthless' within the Description.
13. Enter $0 for Proceeds.
14. Enter the amount of the loss for Cost or other basis.
15. Select Continue.

IRS Publication 550, page 85, states:

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.

Was the debt dissolved in bankruptcy in 2024 or 2025?  Page 84 states:

You may be able to deduct the amount owed to you when you figure your tax for the year the debt becomes worthless.

The $3,000 limit is the amount of capital loss carryover that can be used to offset ordinary income.  There is no limit on how much of the carryover can be used to offset capital gains.  

So, if you report a loss of $10,000 in 2025 and you have no other sales of capital assets to report in 2025, you will be able to claim $3,000 and carryover $7,000.

In 2026, you have a loss on capital assets of $1,000.  The carryover covers the $1,000 as well as the $3,000 that can be used to offset ordinary income. You are left with $3,000 to carryover to 2027.

[kpankpow]

Thank you!!

[kpankpow]

A follow-up on this. It appears I need to include a "Bad Debt Statement" explaining the details, attached to my return. Questions - 

1. Is that correct, and if so will I need to print the federal return off and mail it with the bad debt statement?

2. I live in a state where I'm required to efile the state return. In Turbotax online version, is there an option to print the federal return, and still efile the state return? I understand I may need to still pay to efile both, but I want to confirm I'll have the option to print the Federal return and mail.

[Vanessa A]

1.  Yes, that is correct.  You will need to attach the details of how you try to collect and why it is not collectible and anything else you have to support the statement that you have no way of collecting your deposit.

2.  Which state do you live in?  In general, no, you cannot print and mail your federal return and then e-file the state.  You generally must e-file the federal in order to e-file the state.  Some states that require e-file do have exceptions when it comes to having to mail your federal return. 

[kpankpow]

Understood on Q1. For Q2 - New York

[JotikaT2]

New York only requires electronically filed returns if your software is able to.  Since you have to mail your federal return in, you will not have a federal return that was electronically filed.  Therefore, it is not possible to e-file your state return.  

See this link for the address to use to mail your New York state tax return.

@kpankpow