This Chief Counsel Advice memorandum addresses the deductibility of theft losses under Internal Revenue Code (“Code”) § 165 for five hypothetical taxpayers (Taxpayers 1 through 5) who were victims of various scams in 2024. The memorandum aims to determine if these taxpayers sustained a theft loss deductible in 2024, considering the specific facts of each scenario and the relevant tax law.

Situations Covered

The memorandum analyzes five distinct scam scenarios:

Taxpayer 1: Compromised Account Scam Taxpayer 1 was contacted by someone impersonating a financial institution’s fraud specialist who fraudulently induced Taxpayer 1 to authorize distributions from IRA and non-IRA accounts and transfer the funds to new accounts controlled by the scammer. The funds were then moved overseas, and recovery prospects were low.
Taxpayer 2: Pig Butchering Investment Scam Taxpayer 2 responded to an unsolicited email advertising cryptocurrency investments. After initial small, successful investments and withdrawals, Taxpayer 2 invested a larger sum from IRA and non-IRA accounts, only to be denied withdrawal and discover the scheme was fraudulent. The scammer remained unidentified.
Taxpayer 3: Phishing Scam Taxpayer 3 received a phishing email and was tricked into providing login credentials for IRA and non-IRA accounts, leading to unauthorized distributions to an overseas account. Recovery prospects were low, and Taxpayer 3 did not authorize the transactions.
Taxpayer 4: Romance Scam Taxpayer 4 developed an online romantic relationship with an impersonator who convinced Taxpayer 4 to authorize distributions from IRA and non-IRA accounts and transfer the funds for purported medical expenses. The scammer then ceased contact, and recovery was unlikely.
Taxpayer 5: Kidnapping Scam Taxpayer 5 was contacted by an impersonator claiming to have kidnapped Taxpayer 5’s grandson and demanding ransom. Under duress and believing a cloned voice, Taxpayer 5 authorized distributions from IRA and non-IRA accounts and transferred the funds to an overseas account. The kidnapping was false, and recovery prospects were low.

Questions Addressed

The primary question the memorandum seeks to answer is whether Taxpayers 1 through 5 sustained a theft loss under § 165 that is deductible in 2024. This overarching question encompasses several sub-issues:

Did the scams constitute a theft under § 165 and applicable state law?
In what year was the loss sustained?
What is the amount of the theft loss?
Was the loss incurred in a transaction entered into for profit under § 165(c)(2)?
Is the loss subject to the personal casualty loss disallowance under § 165(h)(5)?
Are the taxpayers eligible for the Ponzi loss safe harbor in Rev. Proc. 2009-20?
What are the tax consequences of distributions from IRA accounts involved in the scams?

Analysis of Statutes, Regulations, and Cases

The memorandum analyzes several key provisions of the Internal Revenue Code, Treasury Regulations, Revenue Rulings, Revenue Procedures, and relevant case law:

Section 165(a) provides a deduction for losses sustained during the taxable year and not compensated by insurance or otherwise.
Section 165(c) limits deductible losses for individuals to those incurred in a trade or business, in a transaction entered into for profit, or personal casualty losses. The memorandum emphasizes that for tax years 2018 through 2025, § 165(h)(5) generally disallows personal casualty losses unless attributable to a federally declared disaster or to the extent of personal casualty gains.
Section 165(e) specifies that theft losses are treated as sustained in the year the taxpayer discovers the loss. The memorandum cites Treas. Reg. § 1.165-1(d)(2), (d)(3) and Treas. Reg. § 1.165-8(a)(2), along with Rev. Rul. 2009-9 and Vennes v. Commissioner, T.C. Memo. 2021-93, to highlight that a loss is not sustained if there is a reasonable prospect of recovery at the end of the year. A reasonable prospect of recovery exists when there are bona fide claims with a substantial possibility of success, as established in Ramsay Scarlett & Co. v. Commissioner, 61 T.C. 795, 811 (1974), aff’d, 521 F.2d 786 (4th Cir.1975), and further discussed in Jeppsen v. Commissioner, 128 F.3d 1410, 1415-16 (10th Cir. 1997) and U.S. v. S.S. White Dental Mfg. Co., 274 U.S. 398, 402-03 (1927).
Section 165(b) limits the deductible loss to the taxpayer’s adjusted basis in the property, as also noted in Treas. Reg. § 1.165-1(c). The memorandum cites Washington Mutual. Inc. v. United States, 636 F.3d 1207, 1217 (9th Cir. 2011), Black & Decker Corp. v. United States, 436 F.3d 431, 435 (4th Cir. 2006), Borg v. Commissioner, 50 T.C. 257, 263 (1968), and O’Meara v. Commissioner, 8 T.C. 622, 632–33 (1947), emphasizing that a loss deduction is generally not allowed for unrealized income.
The definition of "theft" under § 165 is broadly construed to include "any criminal appropriation of another’s property to the use of the taker, including theft by swindling, false pretenses and any other form of guile," as per Rev. Rul. 2009-9 and Treas. Reg. § 1.165-8(d), which includes larceny and embezzlement. The taxpayer must establish an illegal taking with criminal intent under state law, as supported by Rev. Rul. 2009-9 and Vennes v. Commissioner, T.C. Memo. 2021-93 at 28-29.
The memorandum discusses the requirement that a loss be incurred in "a transaction entered into for profit" under § 165(c)(2). It cites Helvering v. National Grocery Co., 304 U.S. 282, 289 n. 5 (1938), Dewees v. Commissioner, 870 F.2d 21, 33 (1st Cir. 1989), Fox v. Commissioner, 82 T.C. 1001, 1021 (1984), Ewing v. Commissioner, 20 T.C. 216 (1958), aff’d 213 F.2d 438 (2d Cir. 1954), and Wright v. Commissioner, T.C. Memo. 2024-100, 6, noting that a primary profit motive is required. The purchase of securities and financial products is considered prima facie evidence of a profit motive, citing Weir v. Commissioner, 109 F.2d 996, 997-98 (3d Cir. 1940). The memorandum also refers to the guidelines in Ewing, 91 T.C. at 417-18 (discussing Fox) and the requirement of an ultimate intention of producing taxable income from Miller v. Commissioner, 836 F.2d 1274, 1278–79 (10th Cir. 1988). The origin of the transaction is crucial in determining profit motive, as per U.S. v. Gilmore, 372 U.S. 39, 49 (1963) and Deputy v. du Pont, 308 U.S. 488, 494 (1940).
The Ponzi loss safe harbor provided in Rev. Proc. 2009-20, as modified by Rev. Proc. 2011-58, allows taxpayers to claim a theft loss in limited circumstances even with a prospect of recovery if specific requirements are met. These requirements include being a "qualified investor" who incurred a "qualified loss" from a "qualified investment" in a "specified fraudulent arrangement," defined in Section 4.01 of Rev. Proc. 2009-20 as an arrangement where a lead figure receives funds, purports to earn income, reports fictitious income, makes payments to some investors from other investors’ funds, and appropriates investor funds. A "qualified loss" requires the lead figure to be charged with or subject to a criminal complaint alleging theft.
Section 408(d)(1) states that distributions from an IRA are generally included in gross income. The memorandum cites Roberts v. Commissioner, 141 T.C. 569, 582 & n.19 (2013) and Balint v. Commissioner, T.C. Memo. 2023-118, noting that unauthorized fraudulent withdrawals from an IRA may not result in taxable income to the owner if they did not request or benefit from the distribution.

Conclusions

Based on its analysis, the memorandum reaches the following conclusions:

Taxpayers 1, 2, and 3 sustained a theft loss under § 165 in 2024 because the scams involved criminal fraud constituting theft under state law, the losses were discovered in 2024 with no reasonable prospect of recovery, and the losses were incurred in transactions entered into for profit. The amount of the deductible loss is limited to their basis in the stolen funds, and they will have income tax consequences related to the IRA distributions and potential gains or losses on the non-IRA account assets.
Taxpayers 4 and 5 sustained a theft loss in 2024. However, these losses are considered personal casualty losses under § 165(c)(3) because the transactions (voluntary transfers based on deceit or duress in non-investment contexts) were not entered into for profit. As personal casualty losses are generally disallowed under § 165(h)(5) for 2018 through 2025 (absent personal casualty gains or a federally declared disaster), Taxpayers 4 and 5 cannot deduct their theft losses in 2024. They will still have income tax consequences related to the IRA distributions and potential gains or losses on the non-IRA account assets.
None of the Taxpayers (1 through 5) are eligible for the Ponzi loss safe harbor under Rev. Proc. 2009-20. Taxpayers 1, 3, 4, and 5 did not invest in a "specified fraudulent arrangement" that purported to earn income for them. While Taxpayer 2’s situation might arguably resemble a "specified fraudulent arrangement," the loss is not a "qualified loss" because the "lead figure" (Scammer A) was never charged with a crime or subject to a criminal complaint. Additionally, the memorandum notes that the safe harbor is only available to taxpayers with an otherwise allowable theft loss, which Taxpayers 4 and 5 do not have due to the personal casualty loss disallowance.

The memorandum can be downloaded via this link: CCA 202511015

Prepared with assistance from NotebookLM.