Which of the following statements is true regarding the classification of nonbusiness bad debts?

The classification of nonbusiness bad debts is important for tax purposes because it affects how these losses are treated on a taxpayer's return. Nonbusiness bad debts refer to debts that arise from personal loans or similar transactions rather than from business activities.

When a nonbusiness bad debt becomes worthless, it results in a short-term capital loss, regardless of how long the debt was held. This is because nonbusiness bad debts are considered short-term by their very nature; they are treated as if they had been held for one year or less, irrespective of the actual holding period. This treatment allows the taxpayer to offset other capital gains with the loss, but if there are no gains to offset, the taxpayer can use the loss to reduce ordinary income up to a certain limit.

The classification as short-term capital loss is crucial, as it affects the tax implications connected to such losses compared to how business bad debts are managed. Business bad debts can be deducted as ordinary losses, which typically provides a more favorable tax treatment than capital losses.

In summary, recognizing nonbusiness bad debts as resulting in short-term capital losses is key for effectively managing taxes and utilizing any allowable deductions against other income.