"There are two kinds of bad debts – business and nonbusiness.
Generally, a business bad debt is one that comes from operating your trade or business.
The following are examples of business bad debts (if previously included in income):
Loans to clients and suppliers
Credit sales to customers, or
Business loan guarantees
A business deducts its bad debts from gross income when figuring its taxable income. Business bad debts may be deducted in part or in full. You can claim a business bad debt using either the specific charge-off method or the nonaccrual-experience method.
All other bad debts are nonbusiness. Nonbusiness bad debts must be totally worthless to be deductible. You cannot deduct a partially worthless nonbusiness bad debt.
A debt becomes worthless when the surrounding facts and circumstances indicate there is no reasonable expectation of payment. To show that a debt is worthless, you must establish that you have taken reasonable steps to collect the debt. It is not necessary to go to court if you can show that a judgment from the court would be uncollectible. You may take the deduction only in the year the debt becomes worthless. You do not have to wait until a debt is due to determine whether it is worthless.
A nonbusiness bad debt is reported as a short–term capital loss in Part 1 on Form 1040, Schedule D (PDF). It is subject to the capital loss limitations. A nonbusiness bad debt deduction requires a separate detailed statement attached to your return.
For more information on nonbusiness bad debts, refer to Publication 550, Investment Income and Expenses. For more information on business bad debts, refer to Publication 535, Business Expenses.
Due to the passive loss limitation rules, your losses from the rental properties will not be allowed to offset other income. Please see and complete Form 8582. As for the bad debt, if it is completely worthless you may be able to deduct this bad debt. For more details here is an excerpt from the IRS: