On January 17, 2025, the Office of Chief Counsel at the Internal Revenue Service (IRS) issued a memorandum (Number: 202511015) clarifying when taxpayers may claim theft loss deductions under Internal Revenue Code §165 for funds lost to scams. This guidance responds to increasing concerns over various fraudulent schemes that have led to substantial taxpayer losses.
Overview of the Issue
The memorandum analyzes five hypothetical taxpayers who, during 2024, were victims of scams involving deceitful actors (referred to as “Scammer A”). The losses were reported to law enforcement and financial institutions, with no reasonable prospects of recovery.
The key question addressed is whether these taxpayers can deduct their losses as theft under IRC §165 in the 2024 tax year.
IRS Conclusion
The IRS concluded that:
- A theft loss deduction is permitted under §165 if the loss stems from a criminal act (e.g., larceny, embezzlement, fraud) under applicable state law.
- The loss must be discovered in 2024 and deemed non-recoverable within that same year.
- The deductible amount is limited to the taxpayer’s basis in the lost property (usually the amount originally paid or invested).
However, eligibility for deduction also depends on the purpose of the transaction that led to the loss.
Profit Motive vs. Personal Motive
- Taxpayers 1, 2, and 3 suffered losses in transactions entered into for profit (e.g., legitimate-looking investment platforms or account transfers intended for reinvestment). These are deductible under §165(c)(2).
- Taxpayers 4 and 5 suffered losses from scams based on personal relationships or emotional manipulation (e.g., romance or kidnapping scams). Since these were not entered into for profit, their losses are not deductible due to the Tax Cuts and Jobs Act (TCJA), which disallows most personal casualty and theft losses for tax years 2018 through 2025.
Ponzi Scheme Safe Harbor Not Applicable
None of the taxpayers qualified for the Ponzi scheme safe harbor under Rev. Proc. 2009-20 and 2011-58 because:
- The scammers did not operate a structured investment fraud with a lead figure,
- No indictment or criminal complaint was filed against the scammer,
- No fictitious income or returns were reported to victims.
Even Taxpayer 2, who was misled into a fraudulent “investment platform,” could not use the safe harbor because Scammer A was never identified or charged.
Tax Treatment and Documentation
- The year of deduction is when the loss is discovered, and recovery is deemed unlikely.
- The deduction is limited to the taxpayer’s basis in the funds.
- IRA distributions involved in scams are generally taxable, but the distributed amounts can form the basis for calculating theft loss deductions.
- Victims must retain adequate documentation and show no reasonable prospect of recovery.