(a) Partial worthlessness—(1) Applicable to specific debts only. A deduction under section 166(a)(2) on account of partially worthless debts shall be allowed with respect to specific debts only.
(2) Charge-off required. (i) If, from all the surrounding and attending circumstances, the district director is satisfied that a debt is partially worthless, the amount which has become worthless shall be allowed as a deduction under section 166(a)(2) but only to the extent charged off during the taxable year.
(ii) If a taxpayer claims a deduction for a part of a debt for the taxable year within which that part of the debt is charged off and the deduction is disallowed for that taxable year, then, in a case where the debt becomes partially worthless after the close of that taxable year, a deduction under section 166(a)(2) shall be allowed for a subsequent taxable year but not in excess of the amount charged off in the prior taxable year plus any amount charged off in the subsequent taxable year. In such instance, the charge-off in the prior taxable year shall, if consistently maintained as such, be sufficient to that extent to meet the charge-off requirement of section 166(a)(2) with respect to the subsequent taxable year.
(iii) Before a taxpayer may deduct a debt in part, he must be able to demonstrate to the satisfaction of the district director the amount thereof which is worthless and the part thereof which has been charged off.
(3) Significantly modified debt—(i) Deemed charge-off. If a significant modification of a debt instrument (within the meaning of § 1.1001-3) during a taxable year results in the recognition of gain by a taxpayer under § 1.1001-1(a), and if the requirements of paragraph (a)(3)(ii) of this section are met, there is a deemed charge-off of the debt during that taxable year in the amount specified in paragraph (a)(3)(iii) of this section.
(ii) Requirements for deemed charge-off. A debt is deemed to have been charged off only if—
(A) The taxpayer (or, in the case of a debt that constitutes transferred basis property within the meaning of section 7701(a)(43), a transferor taxpayer) has claimed a deduction for partial worthlessness of the debt in any prior taxable year; and
(B) Each prior charge-off and deduction for partial worthlessness satisfied the requirements of paragraphs (a) (1) and (2) of this section.
(iii) Amount of deemed charge-off. The amount of the deemed charge-off, if any, is the amount by which the tax basis of the debt exceeds the greater of the fair market value of the debt or the amount of the debt recorded on the taxpayer's books and records reduced as appropriate for a specific allowance for loan losses. The amount of the deemed charge-off, however, may not exceed the amount of recognized gain described in paragraph (a)(3)(i) of this section.
(iv) Effective date. This paragraph (a)(3) applies to significant modifications of debt instruments occurring on or after September 23, 1996.
(b) Total worthlessness. If a debt becomes wholly worthless during the taxable year, the amount thereof which has not been allowed as a deduction from gross income for any prior taxable year shall be allowed as a deduction for the current taxable year.
[T.D. 6500, 25 FR 11402, Nov. 29, 1960, as amended by T.D. 8763, 63 FR 4396, Jan. 29, 1998]
Notes of Decisions
Cited in
24
cases, 1961–2017 · leading case:
Rutter v. Comm'r, 2017 T.C. Memo. 174 (Tax Ct. 2017).
Rutter v. Comm'r, 2017 T.C. Memo. 174 (Tax Ct. 2017).
· cites it 10× “To give rise to a deduction under section 166(a)(1) , a debt must have become wholly worthless during the tax year. Sec. 1.166-3(b), Income Tax Regs.”
VHC, Inc. v. Comm'r, 2017 T.C. Memo. 220 (Tax Ct. 2017).
· cites it 2× “A nonbusiness bad debt may be deducted, but only when it becomes completely worthless in the year for which it is claimed, and then only as a short-term capital loss.”
Herrera v. Comm'r, 2012 T.C. Memo. 308 (Tax Ct. 2012).
· cites it 2× “Business bad debts may be deducted against ordinary income whether wholly or partially worthless during the year (to the extent of the amount that becomes worthless). Sec. 1.166-3, Income Tax Regs. A nonbusiness bad debt may be deducted, but only when it becomes completely…”
Haney v. Portfolio Recovery Assocs., L.L.C., 837 F.3d 918 (8th Cir. 2016).
“§ 166(a)(2))); see also 26 C.F.R. § 1.166-3 (a)(2)(i) ("[T]he amount which has become worthless shall be allowed as a deduction under section 166(a)(2) but only to the extent charged off during the taxable year.”
Kenna Trading, LLC v. Comm'r, 143 T.C. 322 (Tax Ct. 2014).
· cites it 2× “Respondent distills the above requirements into four elements: (1) a charge-off for a partially worthless debt, (2) proof of a trade or business, (3) proof of worthlessness, and (4) proof of basis in the debt.”
Brimberry v. Comm'r, 35 T.C.M. 900 (Tax Ct. 1976).
· cites it 2× “Section 166(a)(2) generally provides for a deduction for the partial worthlessness of a debt to the extent that the taxpayer is able to demonstrate to the satisfaction of respondent that, upon consideration of all the facts and circumstances, including the value of the…”
Daniel Haney v. Portfolio Recovery Assocs., 895 F.3d 974 (8th Cir. 2016).
“Upon sale of a completely charged-off account, the creditor's basis likely will have been adjusted to zero, and the entire proceeds of the sale must recognized as income.”
Hajiyani v. Comm'r, 2001 T.C. Summary Opinion 183 (Tax Ct. 2001).
· cites it 2× “He "may allow" the deduction of a partially *308 worthless debt in an amount "not in excess of the part charged off within the taxable year".”
Bettinger v. Comm'r, 29 T.C.M. 52 (Tax Ct. 1970).
· cites it 4× “- For purposes of paragraph (1), the term "nonbusiness debt" means a debt other than - (A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or (B) a debt the loss from the worthlessness of which is incurred in the taxpayer's…”
Fries v. Comm'r, 1997 T.C. Memo. 93 (Tax Ct. 1997).
· cites it 2× “166-3, Income Tax Regs. Nonbusiness bad debts may be deducted, but only if they are entirely worthless in the year claimed; they are, moreover, subject to the same limitations that apply to short-term capital losses.”
Robertson v. Comm'r, 47 T.C.M. 1468 (Tax Ct. 1984).
· cites it 2× “Neither have petitioners claimed a partially worthless debt deduction pursuant to section 1.166-3(a), Income Tax Regs.”
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