26 U.S.C. § 166: Bad debts

There shall be allowed as a deduction any debt which becomes worthless within the taxable year. When satisfied that a debt is recoverable only in part, the Secretary may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. For purposes of subsection (a), the basis for determining the amount of the deduction for any bad debt shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property. subsection (a) shall not apply to any nonbusiness debt; and where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year. a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or a debt the loss from the worthlessness of which is incurred in the taxpayer’s trade or business. This section shall not apply to a debt which is evidenced by a security as defined in section 165(g)(2)(C). For disallowance of deduction for worthlessness of debts owed by political parties and similar organizations, see section 271. For special rule for banks with respect to worthless securities, see section 582. The amendments made by this section [amending this section and sections 81, 108, 461, and 805 of this title] shall apply to taxable years beginning after December 31, 1986 . such change shall be treated as initiated by the taxpayer, such change shall be treated as made with the consent of the Secretary, and in the case of a taxpayer maintaining a reserve under section 166(f), be reduced by the balance in the suspense account under section 166(f)(4) of such Code as of the close of such last taxable year, and be taken into account ratably in each of the first 4 taxable years beginning after December 31, 1986 .” Except as provided in subsections (b) and (c), the amendments made by the first section of this Act [amending this section and section 81 of this title ] shall apply to taxable years ending after October 21, 1965 . the taxpayer before October 22, 1965 , claimed a deduction, for a taxable year ending before such date, under section 166(c) of the Internal Revenue Code of 1986 [formerly I.R.C. 1954] for an addition to a reserve for bad debts on account of debt obligations described in section 166(g)(1)(A) of such Code (as amended by the first section of this Act), and the assessment of a deficiency of the tax imposed by chapter 1 of such Code for such taxable year and each subsequent taxable year ending before October 22, 1965 , is not prevented on December 31, 1966 , by the operation of any law or rule of law, Section 166(g)(2) of the Internal Revenue Code of 1986 (as amended by the first section of this Act) shall apply to taxable years beginning after December 31, 1953 , and ending after August 16, 1954 .”