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The Tax Prophet Newsletter   Issue # 65 September, 2008

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In This Issue:
Introduction
Theft Loss
Recovery
NOL
Conclusion


Theft Loss Deduction

Introduction

Taxpayers are allowed a deduction for property taken by theft. Theft includes larceny, embezzlement, obtaining money or property under false pretenses (such as swindles and Ponzi or pyramid schemes).

While the loss reduces a victim's tax bite, the timing rules for claiming the deduction are tricky.


Theft Loss

The theft-loss rule is relatively straightforward: In the year a theft is discovered, a loss may be claimed as long as it is not compensated for by insurance or otherwise.

Note: the law focuses on the year of discovery, not the year in which the theft may have occurred.

In general, if the theft involves personal property, the loss is reduced by $100, plus an additional amount equal to 10% of taxpayer's adjusted gross income (AGI).

Example: Taxpayer whose AGI is $125,000 suffers a $50,000 theft loss of personal property. The deductible portion for the loss is $37,400: $50,000 - $12,600 ($100 + $12,500 - 10% of AGI).


Recovery Prospects

The most challenging aspect of the theft-loss rule is when to claim it. The regulations state that a theft loss occurs only when there is "no reasonable prospect of recovery." IRS interprets this strictly: as long as there is a reasonable chance to recover the loss through insurance, third parties or by litigation, taxpayers cannot take the deduction.

Generally, taxpayers filing a lawsuit or claim in bankruptcy cannot deduct the loss until the legal proceeding is resolved, which means the theft loss is often postponed for years.

Note: If there is a reasonable prospect for recovery for only a portion of the loss, the balance may be deducted in the year of discovery.


NOLs

Unlike most personal deductions, to the extent the loss is not fully absorbed in the current year, it generates a net operating loss (NOL) that may be carried back 3 years (the 2-year carryback rule is expanded to 3 years for thefts) or forward 20 years. Thus, the loss may offset income in other years, a huge benefit.


Conclusion

Remember, the loss occurs in the year of discovery, even if the actual theft occurred years earlier. Also, as long as there is a reasonable prospect for recovery, taxpayers must wait until the outcome is known before claiming the deduction.



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All contents copyright 2008 Robert L. Sommers, attorney-at-law. All rights reserved. This newsletter provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet is a registered trademark of Robert L. Sommers.