International bad debt, non-business
April 8, 2019 8:22 PM   Subscribe

I pre-ordered something from a manufacturer in Germany last year who subsequently went bankrupt. Can I safely write this off as bad debt, non-business?

You are not my accountant, of course. As a note, my credit card company was not willing to do a chargeback on it.

I pre-ordered a widget directly from a German manufacturer (so not something explicitly speculative like Kickstarter) that went under before it shipped. The company went through the legal bankruptcy process, I have some paperwork to prove it. My understanding is that there were no funds left for creditors such as myself but I didn't really have the means to deal with finding out exactly what happened while dealing with international bankruptcy and a relatively small amount of money. That said, being able to deduct the loss would save about $130 in taxes.

My reading of things says that I could declare this as bad debt, non-business. Does my understanding sound correct and if so, is there any reason not to do so? If it's likely to chew up a bunch of my time if I get audited, it may not be worth it. If it were a US company with clear rules on bankruptcy that I understand, I wouldn't be too concerned about it, but the international part makes me a little leery.
posted by Candleman to Work & Money (1 answer total)
It seems legit. You clear the three part test for a non-business bad debt:
1. It was a bona fide debt. That is, you expected something in return. It was not a gift. For example, pre-payment to a contractor is considered a loan.
2. You have a basis in the debt. That is, you paid cash out of pocket. (For example, unpaid money owed for work you performed is not considered bad debt since you didn't pay cash out of your pocket for the debt.)
3. It is totally worthless. You did not receive partial payment of the debt.

You must fill out Form 8949 describing the debt. Bankruptcy or termination of the company would be evidence of the worthless debt. If you are deducting it for 2018, the debt must have become worthless in 2018.

From IRS instruction: a nonbusiness bad debt deduction requires a separate detailed statement attached to your return. The statement must contain: a description of the debt, including the amount and the date it became due; the name of the debtor, and any business or family relationship between you and the debtor; the efforts you made to collect the debt; and why you decided the debt was worthless. TurboTax or other tax preparation software should allow you to make an attachment to Form 8949.

The bad debt is considered a short term capital loss, so you must first deduct it against any long or short term gains you might have. Obviously, a short term gain deduction would be preferable because it would be at your ordinary tax rate. If all you have is long term gains, then the deduction is less valuable because of the lower long term gains tax rate. If you have neither, then you can deduct up to $3000 from your ordinary income. If the debt is exceeds the $3000 limit, you can carry over the remaining deduction to next year.

I wouldn't worry about being audited as long as you carefully and correctly fill out Form 8949 with attachment. The percentage of people audited each year is minuscule and mostly because of obvious mistakes or missing entries in filling out their returns.
posted by JackFlash at 9:07 PM on April 8 [5 favorites]

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