Theft Loss Deduction

Client got scammed into emptying out their IRA to "invest" in some kind of venture that didn't really exist. Scammer ran off with the money, and the client will never get it back. I know personal theft deductions were eliminated with the passage of the TCJA, but it's different when it's money that is being used in the pursuit of profit, right? It looks like the theft loss can be itemized and used to cancel the IRA income.

https://www.taxprotalk.com/forums/viewtopic.php?f=8&t=15084&p=134584&hilit=ira+theft#p134584

https://www.taxprotalk.com/forums/viewtopic.php?f=8&t=15084&p=134584&hilit=ira+theft#p134584

This case is a little different because the money was first distributed from the IRA and then stolen. So there is taxable income from the distribution and an equal-sized loss from the theft. Rev Rul 09-9 suggests that the theft loss is indeed deductible against the income from the distribution.

How do you get around 165(h)(5)(A), which suspends deductions for "any personal casualty loss" for the years 2018 through 2025? A "personal casualty loss" is defined in 165(h)(3)(B) to be a loss described in 165(c)(3), which includes loss from theft.

How do you get around 165(h)(5)(A), which suspends deductions for "any personal casualty loss" for the years 2018 through 2025? A "personal casualty loss" is defined in 165(h)(3)(B) to be a loss described in 165(c)(3), which includes loss from theft.

I think the situation I'm describing is covered by 165(c)(2): "losses incurred in any transaction entered into for profit, though not connected with a trade or business". It doesn't look like that part was affected by the TCJA.

Rev Rul 09-9 suggests that the theft loss is indeed deductible against the income from the distribution.. How does that work?

Rev Rul 09-9 suggests that the theft loss is indeed deductible against the income from the distribution.. How does that work?

I guess I misspoke there, since Rev Rul 09-9 came out before the TCJA, and some parts may not apply any more. The main point is that all theft losses were deductible until the TCJA came along. The TCJA eliminated the deduction for personal theft losses but kept the deduction for losses of income-producing property (this covers fraudulent investment schemes). At least I think that's what happened. Was wondering if anyone sees it differently.

Even putting aside the TCJA changes, how did that work?

Even putting aside the TCJA changes, how did that work?

I'm not sure I understand. In this case, the client has, say, $100,000 of taxable income from an IRA distribution. He has the $100,000 stolen from him and claims that as an itemized deduction, so the net income is zero.

It sounds like attax is looking for justification for treating the theft as theft of the IRA account, which was an income producing investment the loss of which would still be deductible, instead of treating it as a theft of the cash that was taken from the account, which would not be deductible due to the TCJA.

Maybe if the disbursement from the IRA was made directly to the fraudulent "investment" that would be an easier sell. Barring that, it seems an awful stretch.

It sounds like attax is looking for justification for treating the theft as theft of the IRA account, which was an income producing investment the loss of which would still be deductible, instead of treating it as a theft of the cash that was taken from the account, which would not be deductible due to the TCJA.

Maybe if the disbursement from the IRA was made directly to the fraudulent "investment" that would be an easier sell. Barring that, it seems an awful stretch.

Perhaps I shouldn't have mentioned the IRA, because that part isn't really important. After the distribution, the client had cash, and yes, it was cash that was stolen. However, the theft involved tricking the client into thinking they were making a good investment. My understanding is that Ponzi-scheme losses are still deductible. This wasn't a Ponzi-scheme, but same idea.

Unfortunately what your client has is a theft of cash. And under current tax law, there is no consolation in the form of a tax deduction. The fact that the IRA was involved was the weak and wobbly peg you might have hung an argument for taking a deduction on.

If there is really no hope of recovery from the crook who sold him the bill of goods, he is pretty much out of luck.

Unfortunately what your client has is a theft of cash. And under current tax law, there is no consolation in the form of a tax deduction. The fact that the IRA was involved was the weak and wobbly peg you might have hung an argument for taking a deduction on.

If there is really no hope of recovery from the crook who sold him the bill of goods, he is pretty much out of luck.

But IRS Pub. 547 says "Note that the personal-use property limitation for tax years 2018 through 2025 does not apply to losses on income-producing property, such as losses from Ponzi-type investment schemes."

So when your cash is stolen via a certain kind of investment scheme, it is deductible, right?

This wasn't a Ponzi-scheme, but same idea.. RR 2009-9 only applies to Ponzi-like schemes But my point was simply that After the distribution, the client had cash, and yes, it was cash that was stolen.. Yes, it's an itemized deduction, still deductible, and not treating the theft as theft of the IRA account.

Deductible how, Nilodop? It is a personal loss.

Adding quote from the 4684 instructions:

For tax years 2018 through 2025, if you are an
individual, losses of personal-use property from
fire, storm, shipwreck, or other casualty, or theft
are deductible only if the loss is attributable to a
federally declared disaster (federal casualty
loss). See Pub. 547 for more information.

Pub 547.

Note that the personal-use property limita- tion for tax years 2018 through 2025 does not apply to losses on income-producing property, such as losses from Ponzi-type investment schemes.

.

Actual law.

(c) Limitation on losses of individualsIn the case of an individual, the deduction under subsection (a) shall be limited to—
(1) losses incurred in a trade or business;
(2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and
(3) except as provided in subsection (h), losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.

Instructions to 1040 Schedule A.

Other Itemized Deductions

List the type and amount of each expense from the following list next to line 16 and enter the total of these expenses on line 16. ... Casualty and theft losses of income-producing property from Form 4684, lines 32 and 38b, or Form 4797, line 18a.

Form 4684.

Individuals, enter the amount from income-producing property on Schedule A (Form 1040 or 1040-SR), line 16, or Form 1040-NR, Schedule A, line 7.

I see the two positions here. Tenletters is saying that because the client received the distribution from the IRA and didn’t “invest” the funds in the IRA directly (without a distribution), the theft loss is a personal loss under 165(c)(3). Nilodop is saying that it doesn’t make any difference because an loss resulting from an investment in a Ponzi scheme is a loss from a transaction entered into for profit under 165(c)(2).

I agree with Nilodop. Rev. Rul. 2009-9 holds that a loss resulting from a Ponzi scheme is a theft loss from a transaction entered into for profit under 165(c)(2), not a personal theft loss under 165(c)(3).

I’ve read this thread with interest, because we have a similar situation in our office. This linked thread is good with some good research and insightful comments by Chay:

viewtopic.php?f=8&t=13291&p=120453&hilit=casualty+chay+investment#p120453

I am onboard with the 165(c)(2) angle. As attax says:

However, the theft involved tricking the client into thinking they were making a good investment.

This fits squarely into 165(c)(2), IMO.

The whole IRA thing is irrelevant. Normally, I might say something like, “It’s somewhat relevant because the source of funds could be used as evidence to support the taxpayer’s intent to make an investment.” I mean, if he withdrew a lump sum from his IRA (which was previously invested therein), he’d say he was just changing from one investment to another (and from one investment vehicle to another). Further, if he withdrew a lump sum and nearly that entire amount went to the fraudster, and there was not a large personal expenditure proximate in time to these events, then we have negative evidence that the funds were not used for personal purposes. But like I said, this source of funds issue is irrelevant. Why? Because we don’t need all this evidence. The theft speaks for itself, no matter where the money came from, without needing these supporting facts. These supporting facts just prove an attempted investment was made. The cancelled check (or whatever it was) is proof enough.

Deductible how, Nilodop? It is a personal loss.

I’d think that through. For one thing, OP is stating pretty adamantly that the money, which was given as an investment, was stolen. I’ll take OP’s word for it. This makes it a transaction entered into for profit. Second, and maybe we need to discuss this aspect further, is the nature of the asset that used to make this “investment.” It was cash. Is cash personal in nature (i.e. a personal use asset)? Tenletters is implying that it is. It seems to me that an individual’s cash on hand isn’t anything until deployed (but more on interest-bearing cash below). This isn’t like a residence where personal “use” is easy to determine. If OP’s client gave money to someone who was to buy groceries for the client, but the guy absconded with the money, I’d say that’s a personal/non-deductible theft loss under 165(c)(3). The grocery purchase was not a transaction entered into for profit.

With that said, when it comes to the nature of the asset, I’m wondering if it even matters. I’m wondering because 165(c)(2) uses the word “transaction.” In other words, even if the asset at play is an investment type of asset (or an income producing asset), like the gold coins in the linked thread, does that cause the theft of such coins to fall into (c)(2)? Again, (c)(2) uses the word “transaction.” In the linked thread, this issue is kind of touched on. The conclusion was that the theft of existing investment property/income-producing property is still deductible under the new law. This conclusion was drawn based on references to language on Form 4684 and in Pub 529. Per these sources, the theft of existing investment/income-producing property is still deductible under the new law, even though there has been no “transaction entered into.” This makes sense to me. After all, what’s the difference between (1) a guy who makes a $100k investment and the investment is stolen thereafter (i.e. no transaction) and (2) a guy who believes he’s making a $100k investment so he forks over the $100k (i.e. a transaction), but that money is stolen by the recipient and is never invested? There really isn’t much of a difference. The legal support for the expansive view of the word “transaction” is found in an old case (Terry v. United States, 15 AFTR 493, 10/31/1934):

…it is necessary to construe the word "transaction" as used in section 23 (e) (2) as including the taxpayer's entire relation to the subject-matter of sale, including his acquisition thereof and the cost as determined by his acquisition.

The preceding paragraph doesn’t really matter in OP’s case, but I thought I’d through it out there. The only other thing that comes to mind is that cash, if interest bearing, could be viewed as investment/income-producing property, right? This too doesn’t really matter in OP’s case because we already have a “transaction entered into for profit.” If interest-bearing cash constitutes an investment/income-producing asset, and OP’s cash fit that mold, that would just give OP an added argument in his favor - maybe.

Go back to my groceries example. If you voluntarily cut a check to your “friend,” out of an interest bearing account, and he’s supposed to buy groceries for you…and he absconds with the money…what is the tax result? Well, the “transaction” (buying groceries) wasn’t entered into for profit. But, can we ignore that transactional aspect and simply view our interest-bearing cash as an investment/income-producing asset and that’s that? I wonder. We have basically, and voluntarily in this case, revoked the “interest bearing” aspect of the asset the minute the check is cashed. Does our decision to buy groceries make our loss personal and that’s that? If it doesn’t, does our decision to stop earning interest make our asset not an investment/income-producing one? And note that this situation is one of voluntarily writing a check. There are other ways a thief could steal our money, like him directly taking it from our account. In that situation, though, we haven’t committed to a personal purchase, so our ship isn’t sunk yet. While we also do not have a transaction, we still wonder if the straight taking of our interest-bearing cash constitutes a theft of investment/income-producing property. And what if our bank account was not interest bearing – does that change the analysis?

Oh, so many issues to explore when we have a theft of cash! Interest bearing, non-interest bearing, if it was taken without our knowledge, if it was voluntarily given for some intended purpose…

Thanks for your thoughts on this, Jeff-Ohio. Though it doesn't really matter to my case, I did start to wonder why cash wouldn't be considered an income-producing asset. Even if it earns zero interest, you may be holding the cash specifically to rebalance your portfolio when stock prices fall. I don't have any answers here, but I'm glad to see someone else having some of the same questions as me.