ForEx Scam losses - how to treat

Hello,

I have a Client who fell for a ForEx currency trading scam, to the tune of many tens of thousands of dollars, on MetaTrader5.

As we all know, Casualty and Theft losses have not been a thing from 2017 forward.

However, Client DID enter this scam as an investment. Client has documentation of how much he put into the scam and exactly when, and the exact date when the program traders forced a sale on his account and wiped him out. Could his massive losses be treated as investment losses, and allowed to offset gains plus $3,000 a year in lowered income, for many years to come?

Even if it's a theft as defined by the code?

Client has exact dates when he bought in, and when the (rigged) "Stop loss" happened. So yes, it was a theft, but it was an investment too?

I think the facts determine the tax treatment, i.e., it's not a choice.

But I know no facts about the "forex trading scam". Can you explain in detail please?

Hello,

I have a Client who fell for a ForEx currency trading scam, to the tune of many tens of thousands of dollars, on MetaTrader5.

As we all know, Casualty and Theft losses have not been a thing from 2017 forward.

It sounds to me like you are dealing with sect 165(c)(2) loss which is still allowed as an itemized deduction.

We're awaiting OP's return so we know the complete facts. At least, I am.

Was this a Ponzi scheme covered by those special rules?
Is the entire loss a theft loss, or might there have been a market decline before the theft?
When if at all would he get the capital loss if, say, pre-theft discovery, the value fell from 100 to 75 and then via theft from 75 to 10, the sale price.
Thefts that are deductible are deductible only in the year discovered, which is not necessarily in the year that he was "wiped out".
Where does this "rule" in Pub 547 come from, and would it support OP's idea of a capital loss?

Decline in market value of stock. You can’t deduct as a theft loss the decline in market value of stock acquired on the open market for investment if the decline is caused by disclo- sure of accounting fraud or other illegal miscon- duct by the officers or directors of the corpora- tion that issued the stock. However, you may be able to deduct it as a capital loss on Schedule D (Form 1040) if the stock is sold or exchanged or becomes completely worthless.

. We'd need to know who committed the fraud.

The misc itemized deductions that are not allowed from 2018 thru 2025 include

(3) the deduction under section 165(a) for casualty or theft losses described in paragraph (2) or (3) of section 165(c) or for losses described in section 165(d),

, so is this correct: It sounds to me like you are dealing with sect 165(c)(2) loss which is still allowed as an itemized deduction.

Hello Nilodop,

Client ("the mark") was following buy and sell instructions of two other "investor friends" (who were also leading him on and enticing him to put more money into his Foreign Currency Exchange Account), and then leading him into a MetaTrader5 program enforced "short sale" that wiped out his account balance, taking all his money.

This is a practice the internet apparently refers to as "Fattening and then Butchering the Pig" (gee, how nice the scammers from Asia are!)

But Client does have detail of his MetaTrader5 account, and of his buying and selling and contribution history. ForEx, is short for Foreign Exchange or Foreign Currency Trading.

This just happened the other day to Client, so this would be an issue on the 2022 income tax return.

Will some action be taken that would be evidence of a theft? Is there a reasonable prospect of recovery?

From what you've described so far, I'm not clear that a theft occurred, as distinct from bad investment advice. I can see arguments both ways.

(b) Miscellaneous itemized deductions
For purposes of this section, the term “miscellaneous itemized deductions” means the itemized deductions other than—
…
(3) the deduction under section 165(a) for casualty or theft losses described in paragraph (2) or (3) of section 165(c) or for losses described in section 165(d)

Aha. Got it.

But we still need to know whether this is a theft or a loss from a sale or exchange of a capital asset. Not just a taxpayer choice of treatment.

Here's an article. Forex is no stranger to scams, apparently. https://www.cftc.gov/LearnAndProtect/Ad ... forex.html

Hello Nilodop,

The Capital asset would be the Cash (in US Dollars) he put into the Forex trades, and then lost? Client has retained a firm to help track and recover as much as possible - we shall see how that goes.

Maybe I'm missing something, but I see little, if any, merit in the theft position, especially considering the mark would have profited if the price rose.

As a practical matter it is blatantly obvious that this loss will be reported as a capital loss. The only way this issue could matter is if the IRS were to take the theft position on audit, which strikes me as highly unlikely.

Q: how did the advisors profit?

Rev Rul. 2009-9 sums up the issue of capital loss vs theft:

"The character of an investor’s loss related to fraudulent activity depend on the nature of the investment. For example, a loss that is sustained on the worthlessness or disposition of stock acquired on the open market for investment is capital loss, even if the decline in the value of the stock is attributable to fraudulent activities of the corporation’s officers or directors, because the officers or directors did not have the specific intent to deprive the shareholder of money or property. See Rev. Rul. 77-17, 1977-1 C.B. 44. 5

In the present situation, unlike the situation in Rev. Rul. 77-17, B specifically intended to, and did, deprive A of money by criminal acts. B’s actions constituted a theft from A, as theft is defined for § 165 purposes. Accordingly, A's loss is a theft loss, not a capital loss."

If a theft occurred, no matter when, it was (apparently) discovered in 2022. So to the extent there is a theft loss, that's the year of deduction, but it must be reduced by any reasonable prospect of recovery.

The net theft loss, even for a loss that's connected to a transaction entered into for profit, is still an itemized deduction, albeit not one disallowed. But he'd need to itemize.

If there turns out not to be a theft (unlikely), it's a loss from the sale or exchange of a capital asset, unless there's some special rules for Forex.

If the investment started out as legitimate but declined in value, and then the bad guys got involved and the value went down more, I think we'd have a theft loss measured from the date the theft started and a capital loss measured prior to that date but recognized on the sale date.

Issues arise when there is more than one label that could be put on real-world events. Preparers deal with many issues for the purpose of making decisions as to how to report the events. Here there is clearly a reasonable basis for reporting a capital loss, which is the best position for the TP. I can appreciate that one may think theft loss is the more appropriate position, but I've not heard anyone with that view say that they would not report a capital loss. This issue is moot.

Subject to hearing more facts, I agree, I'd report as capital loss. But the point of TPT is to evaluate the law and risks so clients can make informed decisions.

Thank you all for your advice. I will treat it as an investment loss in January 2023, unless further facts or recovery of money come to pass.

Thank you all for your advice. I will treat it as an investment loss in January 2023, unless further facts or recovery of money come to pass.

So they just took his money and disappeared without a trace. That sounds like theft to me.