Can I deduct an unpaid loan to a foreign relative as a non-business bad debt?

[footballfan_gb]

I loaned a relative of mine 12 years ago $6,000 with the agreement that it would be paid off over time and since it was a relative, it was loaned as no interest. The loan was made in the currency of the country my relative is in. My relative passed away in 2011 and I was hoping I could get it repaid from the estate he left. But his estate itself is in legal troubles due to various heirs fighting over inheritance. I have finally concluded that I have waited too long for it to be resolved with the hope that it will be paid off from the income of the estate. The only proof I have is the money I wired to my relative's sisters bank account and a foreign witness. If I claim this as a bad debt and a capital loss (limited to $3,000 per year), will IRS raise issues as I have limited documentation? Any advice is appreciated.

 

[Taxing Matters]

I see two potential problems. First, you have to take the deduction in the year that it first becomes clear that you cannot collect the debt. You made the loan 12 years ago. Eight years ago the relative died. It typically would be clear within a year or two whether you realistically stand to get repaid. In any event, it was probably clear well before this year that you weren't going to get the money. If the bad debt was apparent for some year prior to 2018 you would need to amend the return for that year to claim the loss. The problem here being that if the year the deduction should have been taken was prior to 2015 you likely cannot amend the return now to get a refund of tax from it. So I can see the IRS questioning the timing of the loss.

Second, lack of documentation is a problem. In general when you loan money, particularly in amounts in the thousands of dollars, usually you'd get a promissory note or other written agreement for the loan. The IRS would expect to see that you have some kind of written contract signed by her obligating her to pay you back. You wired the money not to her account, but to a different relative's account. You did not charge interest. You've also not outlined what efforts, if any, you made to try to collect the money owed. The IRS may well conclude given the lack of documentation and the circumstances that you made a gift of the $6,000 and deny the loss if the return is examined.