Did you loan some money only to realize you’re not getting paid back? If you file the right paperwork, you could get a reduction in your income taxes to lessen the pain.

As a rule, bad debts are considered to be a capital loss. This means you can deduct them to offset capital gains and capital gains only. To do so, you must add a signed letter to your tax return stating that you want to make an election under section 50(1) of the income tax act. The Canada Revenue Agency processes this letter at the same time as your income tax return.

The problem is that capital losses aren't that great from a tax point of view. Like most people, you may not have capital gains to offset, since those are relatively rare. But there's a special kind of loss, known as an Allowable Business Investment Loss, that is much more generous.

ABILs are created when the bad debt results from a loan made to a small business corporation in an arm’s length transaction. In that case, the loss isn't treated like a capital loss, but rather as a bit of a special snowflake. Through a wave of the legislator’s magic wand, it's considered to be a non-capital loss. As such, it can be used to offset all types of income, such as salaries, earnings from a business, or interest. Odds are that you can reduce your taxes almost immediately.

To claim the deduction, you need to make the same section 50(1) election for capital losses. The distinction between regular capital losses and ABILs can sometimes be difficult to make. This is a case where you might want to consult a professional before filing the election to make sure you’re getting it right.