When it comes to bad debt, public or private, the IRS can offer some relief   

I loaned my brother some money a few years ago and it appears that he isn't going to pay me back. Will I be able to take a deduction for the amount I lost on my tax return?  

P.S., Indianapolis  

Although it might seem like this is an issue for you to settle with your brother and not with the IRS, this is one family situation where the IRS may be willing to hear your case. There are circumstances in which you can take deductions on your tax return for losses from bad debts.  

A bad debt occurs when someone owes you money and you determine that you cannot collect the money. In order to take a tax deduction for the bad debt, you must be able to substantiate that the debt exists, and there must be reason to believe that you won't be able to recoup the amount owed to you.  

To show that a debt really exists, it helps to have some documentation associated with the debt. For example, if you have a signed loan document or other receipt, showing the amount you loaned, the date on which the loan was made, and both your name and the name of the person to whom you loaned the money, along with some signatures, that will represent excellent evidence that the loan is real.  

There had to be a genuine expectation of repayment associated with the loan. If you handed your brother the money, along with a pat on the back and the statement, "I don't mind helping you out - don't worry about paying me back," you can't turn around and say you have a bad debt deduction. Instead, call this "loan" what it really is - a gift.  

In addition to a document substantiating the amount you loaned, there must be a real reason to believe that you are not ever going to recover the amount you loaned. A bad debt deduction for a personal loan is an all or nothing proposition. If you receive partial payment on the loan, you can't take a deduction for the amount you didn't receive.  

When you deduct the debt on your tax return, you will use Schedule D, which is the same form you use to report gains and losses from sales of stocks and other capital assets. The bad debt is listed along with short-term sales of property (items owned for one year or less), no matter how many years old the debt is.  

You must include with your tax return a statement indicating the amount of the debt, the date the debt was due, the name of the person to whom you loaned the money and that person's relationship to you (a brother, in your case), what you did to attempt to collect the debt, and what made you determine that the debt was no longer collectible (for example, your brother declared bankruptcy, or told you he would never pay you back).  

The debt gets deducted in the year in which it became worthless. If it was the fall of 1999 when you determined you wouldn't get paid, you'll have to go back and change the 1999 tax return to take the deduction; you can't deduct the debt on your 2000 tax return. When correcting old tax returns (up to three years old), use Form 1040X to amend the return. You can obtain a copy of this form from the IRS at 800-TAX-FORM, or at their web site, www.irs.gov.  

Change in Capital Gain Tax Rates  

Last week's column addressed the changes in the tax law that will go into effect on January 1, 2001, with regard to the rate of tax on capital gains. If you are in the 15% tax bracket for regular income tax, the new law, which lowers the maximum tax rate on capital gain income, applies immediately after 1/1/01 to sales of stocks and other capital assets that have been owned for at least five years.  

If you pay income tax at a rate higher that 15%, the new lower capital gain tax rates applies to sales of stocks and other capital assets that are acquired after 1/1/01 and then held for five years, meaning these people won't see this new lower tax rate until the tax return that is due in April, 2007, at the earliest. For more details on how this new tax works and to which assets it applies, see http://www.funwithtaxes.com/Past_Articles/11_27_00.htm  on the Internet.