§ 1.166-5 Nonbusiness debts.
(a) Allowance of deduction as capital loss.
(1) The loss resulting from any nonbusiness debt's becoming partially or wholly worthless within the taxable year shall not be allowed as a deduction under either section 166(a) or section 166(c) in determining the taxable income of a taxpayer other than a corporation. See section 166(d)(1)(A).
(2) If, in the case of a taxpayer other than a corporation, a nonbusiness debt becomes wholly worthless within the taxable year, the loss resulting therefrom shall be treated as a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year (6 months for taxable years beginning before 1977; 9 months for taxable years beginning in 1977). Such a loss is subject to the limitations provided in section 1211, relating to the limitation on capital losses, and section 1212, relating to the capital loss carryover, and in the regulations under those sections. A loss on a nonbusiness debt shall be treated as sustained only if and when the debt has become totally worthless, and no deduction shall be allowed for a nonbusiness debt which is recoverable in part during the taxable year.
(b) Nonbusiness debt defined. For purposes of section 166 and this section, a nonbusiness debt is any debt other than—
(1) A debt which is created, or acquired, in the course of a trade or business of the taxpayer, determined without regard to the relationship of the debt to a trade or business of the taxpayer at the time when the debt becomes worthless; or
(2) A debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.
The question whether a debt is a
nonbusiness debt is a question of
fact in each particular case.
The determination of whether
the loss on a debt's becoming worthless has been incurred in a
trade or business of
the taxpayer shall, for this purpose, be made in substantially
the same manner for determining whether a
loss has been incurred in a
trade or business for purposes of section 165(c)(1). For purposes of subparagraph (2) of this paragraph,
the character of
the debt is to be determined by
the relation which
the loss resulting from
the debt's becoming worthless bears to
the trade or business of
the taxpayer. If that relation is a proximate one in
the conduct of
the trade or business in which
the taxpayer is engaged at
the time
the debt becomes worthless,
the debt comes within
the exception provided by that subparagraph.
The use to which
the borrowed funds are put by
the debtor is of no
consequence in making a
determination under this paragraph. For purposes of section 166 and this section, a
nonbusiness debt does not include a debt described in section 165(g)(2)(C). See
§ 1.165-5, relating to
losses on worthless
securities.
(c) Guaranty of obligations. For provisions treating a loss sustained by a guarantor of obligations as a loss resulting from the worthlessness of a debt, see §§ 1.166-8 and 1.166-9.
(d) Examples. The application of this section may be illustrated by the following examples involving a case where A, an individual who is engaged in the grocery business and who makes his return on the basis of the calendar year, extends credit to B in 1955 on an open account:
Example 1.
In 1956 A sells
the business but retains
the claim against B.
The claim becomes worthless in A's hands in 1957. A's
loss is not controlled by
the nonbusiness debt provisions, since
the original consideration has been advanced by A in his
trade or business.
Example 2.
In 1956 A sells
the business to C but sells
the claim against B to
the taxpayer, D.
The claim becomes worthless in D's hands in 1957. During 1956 and 1957, D is not engaged in any
trade or business. D's
loss is
controlled by
the nonbusiness debt provisions even though
the original consideration has been advanced by A in his
trade or business, since
the debt has not been created or acquired in connection with a
trade or business of D and since in 1957 D is not engaged in a
trade or business incident to
the conduct of which a
loss from
the worthlessness of such
claim is a proximate
result.
Example 3.
In 1956 A dies, leaving
the business, including
the accounts receivable, to his son, C,
the taxpayer.
The claim against B becomes worthless in C's hands in 1957. C's
loss is not controlled by
the nonbusiness debt provisions. While C does not advance any consideration for
the claim, or create or acquire it in connection with his
trade or business,
the loss is sustained as a proximate incident to
the conduct of
the trade or business in which he is engaged at
the time
the debt becomes worthless.
Example 4.
In 1956 A dies, leaving the business to his son, C, but leaving the claim against B to his son, D, the taxpayer. The claim against B becomes worthless in D's hands in 1957. During 1956 and 1957, D is not engaged in any trade or business. D's loss is controlled by the nonbusiness debt provisions even though the original consideration has been advanced by A in his trade or business, since the debt has not been created or acquired in connection with a trade or business of D and since in 1957 D is not engaged in a trade or business incident to the conduct of which a loss from the worthlessness of such claim is a proximate result.
Example 5.
In 1956 A dies; and, while his
executor, C, is carrying on
the business,
the claim against B becomes worthless in 1957.
The loss sustained by A's
estate is not controlled by
the nonbusiness debt provisions. While C does not advance any consideration for
the claim on behalf of
the estate, or create or acquire it in connection with a
trade or business in which
the estate is engaged,
the loss is sustained as a proximate incident to
the conduct of
the trade or business in which
the estate is engaged at
the time
the debt becomes worthless.
Example 6.
In 1956, A, in liquidating the business, attempts to collect the claim against B but finds that it has become worthless. A's loss is not controlled by the nonbusiness debt provisions, since the original consideration has been advanced by A in his trade or business and since a loss incurred in liquidating a trade or business is a proximate incident to the conduct thereof.
[T.D. 6500,
25 FR 11402, Nov. 26, 1960, as amended by T.D. 7657,
44 FR 68464, Nov. 29, 1979; T.D. 7728,
45 FR 72650, Nov. 3, 1980]
