Fortunately, the IRS Office of Chief Counsel recently issued guidance (CCA 202511015) outlining when victims of scams may deduct theft losses under IRC §165 for tax years 2018 through 2025. The Brass Tax interpretation of investment theft losses aligns with this new guidance.
The memorandum analyzes five common scam scenarios and applies current law, including the limitations on personal casualty and theft losses imposed by the Tax Cuts and Jobs Act (TCJA).
Key Rule
For tax years 2018–2025, personal casualty and theft losses under §165(c)(3) are disallowed unless attributable to a federally declared disaster (IRC §165(h)(5)). Only theft losses incurred in a transaction entered into for profit under §165(c)(2) are potentially deductible. This article will ignore trade or business casualty or theft losses under §165(c)(1).
Timing of Deduction
The loss is deductible in the year the taxpayer discovers it and determines there is no reasonable prospect of recovery (IRS Reg § 1.165-1(d)(2)). The CCA suggests that the taxpayer should report the incident to their financial institutions and law enforcement and obtain documentation supporting that there is little to no prospect of recovery. This may be obtained through an FBI report.
Below is a summary of the five scenarios analyzed in the CCA, including deductibility conclusions and reasoning. If you have a client who has experienced one of these scenarios, we strongly recommend reading the CCA memorandum to better understand the logic used to allow the deduction.
1. Compromised Account Scam — Deductible
The taxpayer was deceived by a scammer posing as a fraud specialist and directed to transfer IRA and brokerage funds to accounts controlled by the scammer. The taxpayer’s intent was to safeguard and reinvest funds.
Conclusion: Deductible as a theft loss in a transaction entered into for profit. The taxpayer-authorized transfers with the profit motive of protecting investments. Loss is limited to the basis of the stolen property, including amounts distributed from retirement accounts.
In this case, the taxpayer would recognize the IRA distribution in their income, which would establish a basis for claiming the investment theft loss when the funds were transferred to the scammer.
For funds in the taxable brokerage account, if the stocks were not sold before they were transferred, the taxpayer’s loss would be equal to their basis in the stolen investments. If the stocks were sold before they were transferred, the taxpayer would report the gain, and their loss would be increased by the amount of gain reported.
2. Pig Butchering Cryptocurrency Scam — Deductible
The taxpayer transferred IRA and non-IRA funds to a fraudulent crypto platform based on promised high returns. After initial withdrawals reinforced legitimacy, the scammer absconded with subsequent investments.
Conclusion: Deductible. The taxpayer entered the transaction for profit, satisfying §165(c)(2). The loss is deductible in the year recovery is deemed unreasonable, based on law enforcement confirmation.
3. Phishing Scam — Deductible
The taxpayer was tricked into providing account access through phishing. The scammer drained retirement and investment accounts without authorization.
Conclusion: Deductible. Although unauthorized, the loss relates to funds originally invested with a profit motive. Loss is deductible in the year of discovery with no prospect of recovery.
4. Romance Scam — Not Deductible
The taxpayer withdrew funds from IRA and brokerage accounts to help a scammer posing as a romantic partner going through a family emergency. The funds were voluntarily transferred under false pretenses.
Conclusion: Not deductible. The taxpayer lacked profit motive, making this a personal casualty loss under §165(c)(3). Disallowed under §165(h)(5) for tax years 2018–2025.
5. Kidnapping Scam — Not Deductible
The taxpayer was told a family member was kidnapped and transferred funds to secure release.
Conclusion: Not deductible. The transaction was not profit-motivated and constitutes a personal casualty loss disallowed under §165(h)(5).
Observations:
None of the taxpayers in the memorandum qualified for the Ponzi scheme safe harbor. The pig butchering scam did not meet the “qualified loss” criteria since no indictment or criminal charge was filed against the scammer.
The taxpayer’s deductible loss is limited to the taxpayer’s basis in the stolen property per IRC §165(b) and §1011.
Professional Considerations
Tax practitioners should carefully evaluate whether the client’s scam-related loss arose from a profit-driven transaction or is a nondeductible personal casualty loss. Additionally, practitioners must confirm clients took appropriate steps to establish the loss:
- Timely report to law enforcement and financial institutions;
- Obtain written confirmation of no reasonable prospect of recovery;
- Ensure proper basis calculations, particularly for retirement accounts.
Losses meeting the requirements should be reported on Form 4684, Section B (Business and Income-Producing Property) for the year the loss becomes unrecoverable. These are treated as ordinary losses deducted on Schedule A as other itemized deductions not subject to the 2% limitation.
If your client experienced losses due to scams, review these facts closely and read CCA 202511015. Proper documentation and timing are critical to secure a valid deduction under current law.