Ah, I can remember it just as though it were yesterday.
The loan I made to my "friend" that was a matter of life or death.
Having been burned before, I made sure that a promissory note was signed promising to repay.
This way, if worse came to worse, I could take them to court.
Some friend you are.
Rule of thumb; don't lend what you can't afford to lose.
Good practical advice that never seems to do the trick when you're on the losing side.
The appointed time for repayment comes and goes, without so much as a phone call.
You try to locate the individual to no avail.
They seem to have fallen off the face of the earth.
Good thing you had them sign that promissory notice.
Now you will take them to court.
You file the necessary paperwork with the county court and await a response.
The date finally arrives for you to have your day in court with the other individual.
Both the names of the plaintiff (you) and the name of the defendant (your friend) are called.
But wait, the defendant is not in the courtroom.
He never showed up.
You have won your case by default.
Fantastic! Now, the hard part comes in: collecting on the debt.
If you do not know where the individual works or where they bank or whether they own property that you can get your hands on, then your judgment is not worth much without your being able to collect.
It seems as though the expense that you went through to go to court it just that, extra expense on top of the money gone from the loan.
But there is hope that you will be able to make lemonade out of lemons.
Read on.
If you are owed money by an individual that you have tried to collect but are unable to do so, you may be able to deduct the amount on your income tax return as a short term capital loss on Schedule D, Capital Gains and Losses.
In order to file this form, you will need to complete the 1040 long form.
What follows are the qualifications to claim the loss:

1. The debt must be a genuine debt.
   This means that a true debtor creditor relationship must exist between the parties.
   
2. The debt must be of a definite and determinable sum.
   
3. There must be an obligation to repay that is valid and enforceable.
   (One very good reason to get it in writing)
4. Is it a gift or did a loan truly exist? A "loan" between related parties or friends usually does not pass muster for a loan in most cases unless there is a formal loan document drawn up to the effect that the two parties entered into an agreement with a definite sum to be repay at a definite time interval and if repayment did not occur within the interval, whether interest, penalties, or both, would be the result.
   
5. You must have a basis in the debt, that is, you must have previously paid taxes on the amount or the amount must have been loaned out to the individual in question.
   In short, you must have been the owner and in possession of the funds that you loaned out.
   
6. Is the debt totally worthless? This means whether or not you are able to collect on the debt.
   If at any point in time that there remains a ray of hope that you can collect, you can't deduct.
   Only when there is no way in the world that you will ever be able to collect, you may deduct it in the year that it becomes worthless.
   For example, if the individual has filed for bankruptcy protection, it is a sure sign that you, or anyone else that they owe, for that matter, will not be paid.
   
7. According to IRS Publication 550, Investment Income and Expenses, Non Business Bad Debts, one is required to show that they have taken reasonable steps to collect the debt.
   Those reasonable steps are not expressly stated.
   Suffice it to say that reasonable steps are going to involve past due notices and letters being mailed to their residence, by certified or registered mail for good measure to show that you mean business.
   These letters should state the business at hand with a response date and consequences for failure to comply.
   Those consequences can extend themselves to sending the debt to a collection agency, to an attorney's office, etc.
   If your correspondence comes back undeliverable, and you are unable to locate the individual though you search high and low, month after month, exhausting lead at every turn, only to find the trail going cold, you have taken reasonable steps to secure the debt.
   

On Schedule D, Part 1, line 1, column A, enter the debtor's name and "statement attached.
The statement will contain the following information:

• A description of the debt, including the amount and the date that debt became due.
  
• The name of the debtor, and any relationship that exists between you, whether a related party or business.
  
• The efforts that you undertook to collect the debt after you were not paid as agreed.
  
• Why you decided the debt was worthless.
  For example, bankruptcy is undeniable proof of a debt being worthless.
  

On the People's Court of long ago, Doug Llewellyn stated "Don't take the law into your own hands; you take 'em to court!" But even if you don't see a dime from that ruling, with the bad debt deduction, those sour lemons will turn into sweet lemonade.