There are tax savings that can be realized if this happens to you. Believe it or not, the IRS has rules regarding the lending of money to friends and family. If you structure the loan correctly (in the eyes of the IRS) and you never get paid back, then the IRS will actually allow you to consider this as a bad-debt and write the loan off. This is not a difficult strategy to undertake, but you should consult a professional tax advisor before doing so. It is imperative that it be done correctly.
Again, you should consult a tax advisor, but some general requirements are outlined below. The IRS, on a monthly basis, publishes something known as the AFR, which is an interest rate. The AFR (amongst other things) is the rate used between two interested parties that undergo a loan agreement. The first requirement is that you have a loan document prepared and signed by both parties. This loan document should include the following minimum elements (again, consult a tax advisor):
1. The term of the loan
2. The principal amount borrowed
3. The terms for repaying the loan
4. The interest rate
5. The date
6. The signature of both parties
The interest rate quoted in the loan agreement must be greater than the applicable AFR rate (there are three AFR rates depending upon the term of the loan). This is easily done simply by quoting something like “mid-term AFR + 1%”.
A second requirement is that any interest you do receive from the loan must be included as taxable income to you along with other interest income that you receive from savings accounts, bonds, etc. Likewise, any interest that your friend or family pays to you is deductible to them according to the interest deductibility rules.
However, as noted at the beginning, if all the correct elements are in place, the IRS will allow you to write-off bad debt if it has not been paid back according to the terms of the loan document.
Remember to consult a professional tax advisor!