Can You Write Off Being Scammed on Your Taxes?

Losing money to a scam is frustrating, and many wonder if tax deductions offer relief. Tax rules for such losses are specific and have changed significantly. This guide clarifies the current tax treatment of scam losses and which situations may qualify for a deduction.

Current Tax Rules for Scam Losses

For tax years 2018 through 2025, the Tax Cuts and Jobs Act (TCJA) of 2017 suspended deductions for personal casualty and theft losses, which previously included personal scam losses. Consequently, most personal scams, like romance or phishing schemes not involving an investment, do not qualify for a deduction unless tied to a federally declared disaster.

However, certain scam losses may still be deductible if incurred in a business context or from an income-producing activity. For example, a scam impacting a trade or business, or an investment made for profit, may be eligible. The Internal Revenue Service (IRS) distinguishes these from purely personal losses.

The distinction depends on the transaction’s motive. If the primary intent was to generate income or profit, the loss might be deductible, even if the activity was fraudulent. This differs from scams where there was no profit motive, such as romance schemes. Specific rules apply to Ponzi-type schemes.

Deducting Business or Investment Scam Losses

Scam losses related to a trade or business or an income-producing activity may be deductible. If a business is defrauded, or an investment made with a profit motive turns out to be a scam, the resulting financial loss may be deductible.

The loss’s nature determines its classification as an “ordinary loss” or a “capital loss.” An ordinary loss is fully deductible against ordinary income. A capital loss is limited, deductible only against capital gains plus $3,000 per year against ordinary income, with any excess carried forward. Most investment scam losses from fraudulent schemes are classified as ordinary theft losses.

To claim such a loss, it must be a “bona fide loss” and “sustained” for tax purposes. This means the loss must be real, with no reasonable prospect of recovery from insurance, legal action, or other means. The loss is deductible in the tax year it is discovered, when it becomes clear there is no reasonable prospect of recovery.

Comprehensive documentation is essential to substantiate a business or investment scam loss. This includes:
Evidence of fraudulent activity, such as communications with the scammer, fraudulent contracts, or marketing materials.
Proof of the amount lost, such as bank statements, wire transfer records, or investment account statements.
Records of efforts made to recover funds, including police reports, legal filings, or correspondence with financial institutions or regulatory bodies.
Documentation showing the business or income-producing nature of the activity, like business records or investment agreements, to establish profit motive.

Claiming Ponzi Scheme Losses

Losses from Ponzi-type investment schemes have specific IRS guidance, including a “safe harbor” provision outlined in Revenue Procedure 2009-20 and Revenue Ruling 2009-9. This guidance simplifies claiming a tax deduction for these complex losses.

To use this safe harbor, certain conditions must be met:
The lead figure of the fraudulent arrangement must have been charged with fraud, embezzlement, or a similar crime, or there must be evidence of an admission of guilt or a receiver/trustee appointed to freeze assets.
The arrangement must meet the IRS’s definition of a “specified fraudulent arrangement,” involving a lead figure receiving funds, purporting to earn income, reporting fictitious income, and appropriating investor funds.

Under the safe harbor, the deductible loss is calculated as a percentage of the qualified investment. Taxpayers can deduct 95% of their qualified investment if not pursuing third-party recovery, or 75% if they are. The “qualified investment” includes initial and additional investments, reduced by withdrawals and any actual or potential recoveries. This loss is an ordinary theft loss, not a capital loss, and is not subject to the $100 reduction or 10% adjusted gross income limitations applicable to other theft losses.

To claim a Ponzi scheme loss under the safe harbor, taxpayers use Form 4684, Casualties and Thefts. Section C of Form 4684 is designed for these losses and incorporates the calculations. The deductible amount from Form 4684 then flows to Schedule A (Itemized Deductions) of Form 1040, or potentially Schedule C (Profit or Loss from Business) or Schedule E (Supplemental Income and Loss) depending on the investment’s nature and taxpayer involvement. Supporting documentation must be attached, such as:
Proof of investment
Statements of withdrawals
Evidence of the fraudulent arrangement