IRC Section 165 Theft Loss Deduction Explained for Scam Victims

If you have been the victim of investment fraud, you may be entitled to a significant federal tax deduction — even after the Tax Cuts and Jobs Act of 2017. IRC Section 165 is the legal foundation that allows scam victims to deduct financial losses on their federal tax return, and understanding how it works could put real money back in your pocket.

What Is IRC Section 165?

IRC Section 165 is a provision of the Internal Revenue Code that allows taxpayers to deduct certain losses that are not compensated by insurance or otherwise. The section has several subsections that apply to different types of losses. For scam victims, the most important is Section 165(c)(2), which covers losses incurred in any transaction entered into for profit — even if the transaction is not connected to a trade or business.

In plain terms: if you lost money because you were defrauded in what you believed to be an investment, that loss may be deductible on your federal income taxes.

How Did the TCJA Affect Theft Loss Deductions?

The Tax Cuts and Jobs Act of 2017 significantly restricted the casualty and theft loss deduction under IRC Section 165(h). Specifically, the TCJA limited personal casualty and theft deductions to losses arising from federally declared disasters. Many taxpayers — and even some tax professionals — incorrectly concluded that all theft losses were eliminated.

This is not correct. The TCJA’s restrictions applied to personal losses under Section 165(h). Investment-related fraud losses under Section 165(c)(2) were not eliminated. The IRS has continued to recognize these deductions in subsequent guidance, and courts have upheld them in multiple cases involving investment fraud.

What Types of Losses Qualify Under 165(c)(2)?

To qualify under Section 165(c)(2), the loss must have occurred in a transaction that was entered into for profit. This means:

• Ponzi scheme losses: If you invested with an operator who turned out to be running a fraudulent scheme, your loss qualifies. The IRS even issued a special Revenue Ruling (2009-9) providing a safe harbor for Ponzi victims.
• Pig butchering and crypto investment fraud: These schemes typically involve fake trading platforms where victims believe they are making profitable trades. The profit motive is clear.
• Romance scam losses with an investment element: If the scammer directed you to invest money (rather than simply send gifts), the investment component may support a 165(c)(2) deduction.
• Business email compromise (BEC) and wire fraud: When businesses or individuals are tricked into wiring money believing it is a legitimate business transaction, the loss may be deductible.
• Fake real estate investment schemes: Fraudulent offerings for real estate investment trusts, syndications, or rental properties that never existed.

What Does Not Qualify?

Not every financial loss from a scam will qualify under Section 165(c)(2). Losses that are purely personal in nature — such as sending money to a romance scammer as a “gift” with no investment framing — may not meet the profit-motive standard. Similarly, gambling losses and losses from purely speculative activity that does not rise to the level of a profit-motivated transaction may not qualify.

The Reasonable Prospect of Recovery Rule

Under IRC 165, a loss is generally deductible in the year it is “sustained.” A loss is considered sustained when it is evidenced as a closed and completed transaction with no reasonable prospect of recovery. For most scam victims, funds transferred to overseas accounts or cryptocurrency wallets are realistically unrecoverable. If you have an active lawsuit or law enforcement proceeding that could result in recovery, you should discuss timing with a tax professional before filing.

Documentation Requirements

The IRS requires substantiation for any deduction you claim. For a Section 165 scam loss, you should gather:

• Bank and wire transfer records
• Cryptocurrency transaction records
• All communications with the scammer
• Police reports, FTC complaints, or FBI IC3 filings
• Evidence of the fraudulent scheme (screenshots, fake account statements, etc.)

Working With a Qualified CPA

IRC Section 165 deductions for investment fraud are a specialized area of tax law. Many general tax preparers are not familiar with the nuances, particularly the distinction between personal and investment losses under the TCJA. Working with a CPA who has experience with scam victim tax matters ensures your claim is filed correctly, documented properly, and maximized to the full extent the law allows.