United States: Where Have All The Theft Losses Gone?

Introduction

Regrettably, theft losses are on the rise. According to the federal government, senior citizens lost almost $1 billion in Internet and other scams in 2020.1 In 2022, the federal government reported that theft losses had increased 84% year-over-year from 2021 to 2022, with an estimated $3.¹ billion of total losses reported to the Federal Bureau of Investigation's (FBI's) Internet Crime Complaint Center (IC3).² The Federal Trade Commission (FTC) has also reported that $1 billion has been lost since 2021 in scams involving cryptocurrencies.³

Naturally, theft loss victims have questions when they prepare their income tax returns. Prior to the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA), theft loss issues were relatively simple. Taxpayers could claim the theft losses, subject to some restrictions. However, the TCJA has made this formerly simple process much more complicated for theft loss claims that arise from 2018 through 2025.

This article addresses the ambiguity in the law associated with claiming theft losses after the passage of the TCJA. It first discusses the general requirements to claim a theft loss. Then, it discusses the TCJA and its revisions to Code Sec. 165 or the provision in the Code that relates to theft losses. Finally, it provides arguments advanced for and against claiming theft losses after the passage of the TCJA.

Theft Losses Generally

Code Sec. 165 of the Code permits taxpayers to claim losses, including theft losses. Under existing federal case law, a taxpayer may claim a theft loss if the taxpayer can show (1) the occurrence of a theft, (2) the amount of the theft loss, and (3) the date the taxpayer discovered the theft.⁴ Additionally, the taxpayer must show that a third party (e.g., insurance company) will not compensate or reimburse the taxpayer for the theft loss.⁵ As with any deduction, the taxpayer bears the burden of proof in showing satisfaction of all of these elements.⁶

Occurrence of a Theft

To qualify for the theft loss deduction, the taxpayer must first show the actual occurrence of a theft. Under the regulations, theft is "deemed to include, but shall not necessarily be limited to, larceny, embezzlement, and robbery."⁷ Thus, under federal case law:

[T]o qualify for a 'theft' loss within the meaning of section 165[ ] of the Code, the taxpayer needs only to prove that his loss resulted from a taking of property that is illegal under the law of the state where it occurred, and that the taking was done with criminal intent.⁸

Amount of Theft Loss

Taxpayers bear the burden of proving the amount of a claimed theft loss. For these purposes, a theft loss is limited to the lesser of (1) the property's fair market value immediately before the theft and (2) the property's adjusted basis.⁹ To determine fair market value, the governing regulations assume a deemed sale where the "fair market value of the property immediately after the theft [is] considered zero."¹⁰

Timing of the Theft Loss Deduction

To support a theft loss deduction, the taxpayer must show the proper tax year in which the loss occurred.¹¹ Moreover, to the extent the taxpayer satisfies this burden, the taxpayer must further show that there is no reasonable prospect of recovery in the year in which the theft loss deduction is claimed.¹² If there is a reasonable prospect of recovery in the year of the discovery, the timing of the deduction is delayed until the prospect of recovery no longer exists.¹³

Generally, the year of the discovery is the year in which a reasonable person in similar circumstances would have discovered the theft.¹⁴ Moreover, "[a] reasonable prospect of recovery exists when the taxpayer has bona fide claims for recoupment from third parties or otherwise, and when there is a substantial possibility that such claims will be decided in his favor."¹⁵

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Footnotes

1. Luke Barr, Senior Citizens Lost Almost $1 Billion in Scams Last Year: FBI, available at abcnews. go.com/Politics-senior-citizens-lost-billionsscams-year-fbi/story?id=78356859 (last visited on August 4, 2023).

2. Austin Eller, FBI: Losses from Elder fraud cases rose 84% in 2022, available at accesswdun.com/ article/2023/4/118001/fbi-losses-from-elderfraud-cases-rose-84-in-2022 (last visited August 4, 2022).

3. Ramishah Maruf, $1 billion has been lost in cryptocurrency scams since 2021, FTC warns, available at www.cnn.com/2022/06/04/business/cryptocurrency-scammers-ftc-warning/ index.html. 

4. See R.S. Gerstell, 46 TC 161, Dec. 27,937 (1966); M. Monteleone, 34 TC 688, Dec. 24,278; J. H. McCinley, 34 TC 59, Dec. 24,135 (1960).

5. See Code Sec. 165(a).

6. Welch v. Helvering, SCt, 3 ustc ¶1164, 290 US 111, 54 SCt 8 (1933); M. Torres, 121 TCM 1504, Dec. 61,876(M), TC Memo. 2021-66.

7. Reg. §1.165-8(d); see also C.P. Littlejohn, 119 TCM 1274, Dec. 61,650(M), TC Memo. 2020-42 ("As used in Code Sec. 165, the term 'theft' is a word of broad and general connotation, intended to cover any criminal appropriation of another's property, including theft by larceny, embezzlement, obtaining money by false pretenses, and any other form of guile.").

8. Rev. Rul. 72-112, 1972-1 CB 60; see also Edwards v. Bromberg, CA-5, 56-1 ustc ¶9448, 232 F2d 107 (1956); B. P.Citron, 97 TC 200, 207, Dec. 47,513 (1991) ("The law of the jurisdiction where the loss is sustained is applicable to determine whether a theft or embezzlement has occurred.").

9. G. Raifman, 116 TCM 29, Dec. 61,212(M), TC Memo. 2018-101; Reg. §§1.165-7(b)(1) and 1.165-8(c).

10. Reg. §1.165-8(c).

11. See Code Sec. 165(e).

12. See Reg. §1.165-1(d)(3).

13. Id.

14.  V.M. Cramer, 55 TC 1125, 1133, Dec. 30,697 (1971).

15. Baum, 121 TCM 1315, Dec. 61,856(M), TC Memo. 2021-46.

Originally Published by The Tax Magazine

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.