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My wife and I were the victim of a ponzi like investment fraud

where we loaned an individual...
My wife and I were the victim of a ponzi like investment fraud where we loaned an individual money over a two year period (2008-2009). In late 2010 legal action was initiated against this individual and in 2011 this individual was arrested and his trial in Federal Court is still pending as of this date. In May of 2013 the company(bank) that facilatated and made false respresentations involving the theft, admitted their participation and made partial restitution to us for about 60% of the loaned amount. Can I now for this year's taxes, file to deduct the remaining balance of the loss? This amounts to aproximately $50,000.00. I have copies of all legal action in my file. Thank you for your time.
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Answered in 41 minutes by:
9/16/2013
jgordosea
jgordosea, Enrolled Agent
Category: Tax
Satisfied Customers: 3,161
Experience: I've prepared all types of taxes since 1987.
Verified

Greetings,

 

The short answer is that a theft loss must be taken in the year of discovery but there is also a second method for Ponzi scheme losses.

 

Deduction of a theft loss requires establishing that the loss was from theft and that the theft was discovered in the year the taxpayer claims the deduction. And also the amount of the claimed loss and that there is a no reasonable prospect of recovery in the tax year in which the taxpayer claims the loss.

 

You do seem to have enough from your description to be able to establish those items. But since the loss you described was discovered in a prior year, you would need to amend that prior year that was the year of discovery and take the theft loss deduction in that year of discovery.

 

Since the theft loss requirements are difficult to meet for a victim of a Ponzi scheme the IRS developed a safe harbor, which is a means to deduct without strictly meeting the usual theft loss rules.

 

See http://www.journalofaccountancy.com/web/20091552.htm for details on the safe harbor method.

"If a qualified investor follows the procedures described in the revenue procedure, the Service will not challenge:

(1) The treatment of a qualified loss as a theft loss;

(2) The tax year in which the theft was discovered; and

(3) The amount of the deduction.

 

To take advantage of the safe harbor, the investor must multiply the amount of the qualified investment (as defined in the revenue procedure) by 95% for a qualified investor that does not pursue any potential third-party recovery, or by 75% for a
qualified investor that is pursuing or intends to pursue any potential third-party recovery. The investor then subtracts from this product the sum of any actual recovery and any potential insurance or SIPC recovery.

If some amount of the loss is eventually recovered, the investor may have income or an additional deduction in a subsequent year, depending on the actual amount of the loss recovered.

A taxpayer that chooses not to apply the revenue procedure's safe harbor treatment will be subject to all of the generally applicable section 165 provisions governing the deductibility of losses"

 

The safe harbor procedure is to "multiply the amount of the qualified investment (as defined in the revenue procedure) by 95% for a qualified investor that does not pursue any potential third-party recovery, or by 75% for a qualified investor that is pursuing or intends to pursue any potential third-party recovery. The investor then
subtracts from this product the sum of any actual recovery and any potential
insurance or SIPC recovery."

 

In plainer language you would take 75% of your investment and reduce it by your recovery for the amount that you would claim under the safe harbor method.

 

For example, if a taxpayer had an original investment of 120K then you would use 3/4*120 minus 50 reimbursement for a loss of 40K to be claimed under the safe harbor.

If the same taxpayer does not use the safe harbor then 120K-50K reimbursed = 70K theft loss can be claimed in the year that the loss was discovered (so long as the other provisions can be met.)

 

So, you can claim a theft loss in the year it was discovered or use the lesser Ponzi loss in another year for a reduced amount but that safe harbor will not be subject to

as many challenges as the theft loss may be.

 

Whether claiming this as a theft loss in the year of discovery or as a Ponzi loss under Rev. Proc. 2009-20 is best for you is your decision and is likely based on your taxable income in the year of discovery after allowed loss versus your taxable income in the year you would use the safe harbor after allowed loss. The other major factor will be whether it is or is not important to you to have the protection from challenge of the safe harbor.

 

This is involved so you might want to engage a tax practitioner, such as an Enrolled Agent, or confer with your preparer to compare the benefit of the two methods and discuss your tolerance for potential challenges.

 

Sorry the answer got a bit long; but you need to know your options.

 

Please ask if you need more discussion of the methods or clarification.

Thank you.

 

 

 

jgordosea
jgordosea, Enrolled Agent
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Satisfied Customers: 3,161
Experience: I've prepared all types of taxes since 1987.
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Customer reply replied 4 years ago


The theft really was discovered by the investors to be unrecoverable late in 2010. So under the "safe harbor" are you saying that my accountant can ask for an amemded tax return under 2010? Since I have already recieved reimbursement of say 60% of my total loss and my remaining out of pocket is say 50,000. what formula would I use? 95% of total loss - 75% of remaining balance? Also I suffered about $10,000.00 in loss on bank interest on these loans that were supposed to be very short term but ended up being long term. I had no way of paying the loans back until the partial settlement. Can I include interest costs as part of my deductable losses? Thanks so much you have been of great assistance.


 


Steve

Hello again,

 

"are you saying that my accountant can ask for an amemded tax return under 2010?" Yes, a theft loss should be claimed in the year of the discovery by you.

The safe harbor has some leeway as part of that provision is that the year of the loss will not be challenged so there is potential opportunity to use that in another, such as the current, year.

 

The safe harbor formula when there is reimbursement is 75% of the investment less the reimbursement.

For example, if a taxpayer had an original investment of 120K then you would use 90K (3/4*120) minus 50 reimbursement for a loss of 40K to be claimed under the safe harbor.

 

Whether or not you can deduct interest will depend on if that interest was incurred to purchase the investment. If it was, then that is investment interest and likely could be deducted as such.

Any secondary effect of a theft would not usually be considered part of the theft or ponzi loss; but that may be an issue to present to a practitioner you engage that can review all of the facts in your case to apply the rules and regulations.

 

Hope that clarifies for you; but please do ask again if needed.

Thank you.

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