Can a Loss of Business Deposit be written off on Tax Return?
Yes, you may write off the loss, but a more important question is what is the nature of this loss, how and where do you write off this loss?
What is the definition of this loss?
Most likely the definition of this loss would be a bad debt. It cannot be an ordinary loss as the business venture was not initiated. It merely is a loss of a deposit to purchase a new business!
The IRS has identified "two kinds of bad debts – business and nonbusiness". Let us see which definition best suits your individual situation.
Business Bad Debt-Definition
The IRS has defined the "business bad debt as one that comes from operating your trade or business." Typically, a business deducts its bad debts from gross income when figuring its taxable income. Furthermore. business bad debts may be deducted in part or in full.
Based on your facts and circumstances, it seems to me that your loss would not meet the definition of a Business Bad Debt.
Non-Business Bad Debt-Definition
The IRS has defined "all other bad debts are nonbusiness." There are certain conditions that must be met before a taxpayer may claim a a non-business debt.
Based on your facts and circumstances, it seems to me that your loss would tend to meet the definition of a Non-Business Bad Debt.
The IRS has established certain conditions that must be met before you may be able to claim a non-business debt. These are as follows:
1. Nonbusiness bad debts must be totally worthless to be deductible.
This seems to be your situation, especially if you have tried to recover your deposits and this appears to validated by terms of the contract that states the deposits are non-refundable.
2. You cannot deduct a partially worthless nonbusiness bad debt.
3. You must establish that you have taken reasonable steps to collect the debt and the debt is worthless.
Clearly, a letter sent by you to recover your deposits would tend to ensure that efforts have been made to recover your original deposits.
4. A nonbusiness bad debt deduction requires a separate detailed statement outlining the nature of the loss, that must be attached to your individual tax return.
It is not necessary to go to court if you can show that a judgment from the court would be uncollectible. You may take the deduction only in the year the debt becomes worthless.
The IRS has stated that "a debt becomes worthless when the surrounding facts and circumstances indicate there is no longer any chance the amount owed will be paid." Thus, a taxpayer need not have to wait until a debt is due to determine whether it is worthless.
Where do you report a Non-Business Debt?
A nonbusiness bad debt is reported as a short–term capital loss in Part 1 on Form 1040, Schedule D. Per the Tax Code, these net short term capital losses would be subject to the normal capital loss limitations, which is currently $3,000 per year.
Hence, a maximum of $3,000 of losses would be deductible in 2007 and the excess amount would be carried over to 2008 to be offset against future capital gains, and if none available then another $3,000 of losses would be deductible in 2008 with the balance carried over to the future years.