§ 1.166–1 26 CFR Ch. I (4–1–00 Edition)
of certain positions held by a partner- taxable year for which the change is ef- ship which resulted in a loss to a part- fective. ner may be limited or disallowed under (4) Nothwithstanding paragraphs (b) section 465 of 704(d). (1), (2), and (3) of this section, a dealer [T.D. 7968, 49 FR 33445, Aug. 23, 1984] in property currently employing the accrual method of accounting and cur- § 1.166–1 Bad debts. rently maintaining a reserve for bad debts under section 166(c) (which may (a) Allowance of deduction. Section 166 have included guaranteed debt obliga- provides that, in computing taxable in- tions described in section 166(f)(1)(A)) come under section 63, a deduction shall be allowed in respect of bad debts may establish a reserve for section owed to the taxpayer. For this purpose, 166(f)(1)(A) guaranteed debt obligations bad debts shall, subject to the provi- for a taxable year ending after October sions of section 166 and the regulations 21, 1965 under section 166(f) and § 1.166– thereunder, be taken into account ei- 10 by filing on or before April 17, 1986 ther as— an amended return indicating that (1) A deduction in respect of debts such a reserve has been established. which become worthless in whole or in The establishment of such a reserve part; or as will not be considered a change in (2) A deduction for a reasonable addi- method of accounting for purposes of tion to a reserve for bad debts. section 446(e). However, an election by (b) Manner of selecting method. (1) A a taxpayer to establish a reserve for taxpayer filing a return of income for bad debts under section 166(c) shall be the first taxable year for which he is treated as a change in method of ac- entitled to a bad debt deduction may counting. See also § 1.166–4, relating to select either of the two methods pre- reserve for bad debts, and § 1.166–10, re- scribed by paragraph (a) of this section lating to reserve for guaranteed debt for treating bad debts, but such selec- obligations. tion is subject to the approval of the (c) Bona fide debt required. Only a district director upon examination of bona fide debt qualifies for purposes of the return. If the method so selected is section 166. A bona fide debt is a debt approved, it shall be used in returns for which arises from a debtor-creditor re- all subsequent taxable years unless the lationship based upon a valid and en- Commissioner grants permission to use forceable obligation to pay a fixed or the other method. A statement of facts determinable sum of money. A debt substantiating any deduction claimed arising out of the receivables of an ac- under section 166 on account of bad crual method taxpayer is deemed to be debts shall accompany each return of an enforceable obligation for purposes income. of the preceding sentence to the extent (2) Taxpayers who have properly se- that the income such debt represents lected one of the two methods for have been included in the return of in- treating bad debts under provisions of come for the year for which the deduc- prior law corresponding to section 166 tion as a bad debt is claimed or for a shall continue to use that method for prior taxable year. For example, a debt all subsequent taxable years unless the arising out of gambling receivables Commissioner grants permission to use that are unenforceable under state or the other method. local law, which an accrual method (3)(i) For taxable years beginning taxpayer includes in income under sec- after December 31, 1959, application for tion 61, is an enforceable obligation for permission to change the method of purposes of this pargarph. A gift or treating bad debts shall be made in ac- contribution to capital shall not be cordance with section 446(e) and para- considered a debt for purposes of sec- graph (e)(3) of § 1.446–1. tion 166. The fact that a bad debt its (ii) For taxable years beginning be- not due at the time of deduction shall fore January 1, 1960, application for not of itself prevent is allowance under permission to change the method of section 166. For the disallowance of de- treating bad debts shall be made at ductions for bad debts owed by a polit- least 30 days before the close of the ical party, see § 1.271–1.
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(d) Amount deductible—(1) General taxable year of a bad debt, or of a part rule. Except in the case of a deduction of a bad debt, which was allowed as a for a reasonable addition to a reserve deduction from gross income in a prior for bad debts, the basis for determining taxable year shall be included in gross the amount of deduction under section income for the taxable year of recov- 166 in respect of a bad debt shall be the ery, except to the extent that the re- same as the adjusted basis prescribed covery is excluded from gross income by § 1.1011–1 for determining the loss under the provisions of § 1.111–1, relat- from the sale or other disposition of ing to the recovery of certain items property. To determine the allowable previously deducted or credited. This deduction in the case of obligations ac- paragraph shall not apply, however, to quired before March 1, 1913, see also a bad debt which was previously paragraph (b) of § 1.1053–1. charged against a reserve by a tax- (2) Specific cases. Subject to any pro- payer on the reserve method of treat- vision of section 166 and the regula- ing bad debts. tions thereunder which provides to the (g) Worthless securities. (1) Section 166 contrary, the following amounts are and the regulations thereunder do not deductible as bad debts: apply to a debt which is evidenced by a (i) Notes or accounts receivable. (a) If, bond, debenture, note, or certificate, or in computing taxable income, a tax- other evidence of indebtedness, issued payer values his notes or accounts re- by a corporation or by a government or ceivable at their fair market value political subdivision thereof, with in- when received, the amount deductible terest coupons or in registered form. as a bad debt under section 166 in re- See section 166(e). For provisions al- spect of such receivables shall be lim- lowing the deduction of a loss resulting ited to such fair market value even from the worthlessness of such a debt, though it is less than their face value. see § 1.165–5. (b) A purchaser of accounts receiv- (2) The provisions of subparagraph (1) able which become worthless during of this paragraph do not apply to any the taxable year shall be entitled under loss sustained by a bank and resulting section 166 to a deduction which is from the worthlessness of a security based upon the price he paid for such described in section 165(g)(2)(C). See receivables but not upon their face paragraph (a) of § 1.582–1. value. [T.D. 6500, 25 FR 11402, Nov. 26, 1960, as (ii) Bankruptcy claim. Only the dif- amended by T.D. 6996, 34 FR 835, Jan. 18, 1969; ference between the amount received T.D. 7902, 48 FR 33260, July 21, 1983; T.D. 8071, in distribution of the assets of a bank- 51 FR 2479, Jan. 17, 1986] rupt and the amount of the claim may be deducted under section 166 as a bad § 1.166–2 Evidence of worthlessness. debt. (a) General rule. In determining (iii) Claim against decedent’s estate. whether a debt is worthless in whole or The excess of the amount of the claim in part the district director will con- over the amount received by a creditor sider all pertinent evidence, including of a decedent in distribution of the as- the value of the collateral, if any, se- sets of the decedent’s estate may be curing the debt and the financial condi- considered a worthless debt under sec- tion of the debtor. tion 166. (b) Legal action not required. Where (e) Prior inclusion in income required. the surrounding circumstances indi- Worthless debts arising from unpaid cate that a debt is worthless and wages, salaries, fees, rents, and similar uncollectible and that legal action to items of taxable income shall not be al- enforce payment would in all prob- lowed as a deduction under section 166 ability not result in the satisfaction of unless the income such items represent execution on a judgment, a showing of has been included in the return of in- these facts will be sufficient evidence come for the year for which the deduc- of the worthlessness of the debt for tion as a bad debt is claimed or for a purposes of the deduction under section prior taxable year. 166. (f) Recovery of bad debts. Any amount (c) Bankruptcy—(1) General rule. attributable to the recovery during the Bankruptcy is generally an indication
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