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Thank you for your question.
Did you have a sales contract or loan contract with your sister?
Did you charge interest?
You can theoretically take this as a bad debt deduction, but you have some problem here, where if you were audited, you may not be able to sustain the deduction.
1. In order to claim a bad debt, the interest had to have been included in your income tax returns as short term capital gains. (schedule D). So if you did not, you would have to file amended returns showing the interest as interest income.
2. There had to be an intention of making money with this loan. Between relatives the IRS expects the interest to be at FMV (fair market value), which is about 6%.
3. the IRS expects the loan to be inforceable and the IrS interprets this to mean that: (a) there is a signed loan agreement , and (b) there is a payment schedule that includes interest.
you meet half of this requirement. however, oral contracts are infact enforceable. The courts tend to side with the IRS in this matter because loans between relativeds are generally consdiered to not be fully enforceable because most relatives will not actually enforce a loan against a relative. However in at least two court cases, where the relative who owed the money testified convincingly, the court allowed the bad debt deduction. the saving grace was a written signed and agreed to payment plan.
4. Finally, you can not have an ownership interest except to the extent that the property is being sold as an installment agreement. Essentially if I were setting this up, it would have been to sell my inerterst in the auto for the balance of the money I was providing plus interest in an installment loan document.
5. It is not necessary to go to court to prove a good faith effort to collect on this debt. Please read this link: http://www.irs.gov/taxtopics/tc453.html
BotXXXXX XXXXXne: it looks like you could but you do not have documents. You may have to complete the record in order to take this deduction including filng of amended tax returns to claim interest income. You would have some issues to overcome if you were to be audited.
Thank you for getting back to me and clarifyign some of your situation.
1. So you are telling me that you bought the car, and then you had a deal with your sister to purchase the car from you by making payments . IF THIS is the situtaion, in order to take this as a bad debt, your sister had to pay you interest at fair market rates. AND you would have had to report that interest as income.
Now in your first iteration of the question, it played like you had a "loan type" agreement with your sister to purchase this car from you or to at least repay you for the purchase price of the car.
2. BUT NOW from what you are telling me there really is no loan deal to buy the car from you, and the car is at best a gift.
BOTXXXXX XXXXXNE here: if she had an agreement with you to buy this car from you with interest, then it would be a loan. Now she defaults before any payment can be made. THIS would not be deemed as a valid loan unless you had a written document. The IRS will deny the deduction if you did not collect money or attempt to enforce the loan....for example turning it over to a collection agency. Filing a lien on her possessions, etc.
with this scenario you are now presenting, you are not going to be able to capture any of this on your taxes, without raising a red flag and risking audit; and I do not believe you will sustain this at audit without some sort of effort to collect and without having a signed loan contract with your sister.
This will be deemed a gift by the IRS unless when she sells the car, you get the money back. AND THEN, it is weak because you have no signed contract and have not otherwise collected money or reported any income from interest on the loan.
This is not a deductable.