Five years ago,Tom loaned his son John $20,000 to start a business.A note was executed with an interest rate of 8%,which is the Federal rate.The note required monthly payments of the interest with the $20,000 due at the end of ten years.John always made the interest payments until last year.During the current year,John notified his father that he was bankrupt and would not be able to repay the $20,000 or the accrued interest of $1,800.Tom is an accrual basis taxpayer whose only income is salary and interest income.The proper treatment for the nonpayment of the note is:

Question

Quizplus · Accepted Answer

This is a bona fide loan to his son;therefore,Tom is entitled to a bad debt of $21,800 ($20,000 + $1,800;a deduction is allowed for the $1,800 of accrued interest receivable because Tom is an accrual basis taxpayer).The deduction for the current year is limited to $3,000,since the bad debt is classified as a short-term capital loss.

Five Years Ago,Tom Loaned His Son John $20,000 to Start