AN INVESTMENT LOSS OR A THEFT LOSS? THE DISTINCTION MATTERS

A recent ruling deals with a married couple who became victims of a Ponzi scheme by investing with a fund manager - not directly with the perpetrator of the fraud.

The IRS ruled in 2009 that investors who lost money in Bernard Madoff's Ponzi scheme and other similar frauds are entitled to a theft loss deduction rather than an investment loss (Revenue Ruling 2009-9 and Revenue Procedure 2009-20).

In the wake of the earlier IRS pronouncements, one question remained unanswered: What if the investor placed his funds with a legitimate fund manager and that manager invested in the fraudulent scheme? Was it the investor or the legitimate fund manager who suffered the theft loss?

The IRS has answered that question in a Chief Council Memorandum (CCA 201213022). The ruling concludes that the couple is entitled to treat their loss as a theft loss.

This decision is important because a theft loss generally results in a greater tax benefit. It is treated as a fully deductible "ordinary" loss for those who itemize their deductions.

In contrast, investment losses are usually treated as capital losses, which offset capital gains. An individual taxpayer may deduct up to $3,000 in any year as a net loss, and excess capital losses are carried forward to future years.

 
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