Tax Lawyer's Blog

IRS Publication 547 requires a taxpayer claiming a theft loss to prove 4 things: 1) when he first discovered the property was stolen, 2) the fact that the property was, in fact, stolen (i.e. not lost or misplaced), 3) the fact that he owned the property when it was stolen; and 4) whether a claim for reimbursement exists for which there is a reasonable expectation or recovery.

Tax Policy Blog cites a New York Times article stating that those who have allegedly been bilked by the alleged fraudulent schemes of Bernard Madoff (and his investment company, Bernard Madoff Investment Securities) may be able to take a theft loss deduction equal to the amount of their lost investment:

Investors who became victims of Bernard L. Madoff’s now infamous $50 million Ponzi scheme may get some relief through the tax code. The IRS allows taxpayers to deduct theft losses, as long as they exceed 10% of adjusted gross income. But as the New York Times points out, in order to claim the deduction it has to be reasonably clear that an investor will not recoup his or her losses, which can take a while to prove. For example, it is possible that some of the missing funds are sitting in a bank account and could be seized and returned to investors.

Author’s Note: The Times article fails to point out that Madoff was arrested on December 12, 2008, and has not yet been adjudicated guilty of investor fraud.  It is therefore likely that the IRS will deny a 2008 theft loss deduction on the grounds that it has not yet been determined that a theft has in fact occurred.  This means that the investors will not be able to claim their theft losses until both Madoff is adjudicated guilty and there is no reasonable expectation of recovery of the lost funds.

Caveat: See Joe Kristan’s blog post, Theft Losses for Madoff Victims?, for a different opinion on whether or not a conviction or confession will be necessary in order for investors to claim the theft loss.

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