Theft loss deduction requirements.

• Author: Borkes, Jason

Sec. 165 broadly allows taxpayers to deduct losses "sustained during the taxable year and not compensated for by insurance or otherwise." Some examples of losses that are allowed as a deduction under Sec. 165 include wagering losses (Sec. 165(d)), theft losses (Sec. 165(e)), worthless securities (Sec. 165(g)), and disaster losses (Sec. 165(i)). With respect to individual taxpayers, any deduction claimed under Sec. 165 is limited under Sec. 165(c) to:

* Losses incurred in a trade or business;

* Losses incurred in any transaction entered into for profit; and

* Losses arising from fire, storm, shipwreck, or other casualty, or from theft.

In addition, for the third category, Sec. 165(e) states that "any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss."

In a recent case, Baum, T.C. Memo. 2021-46, an individual taxpayer was denied a theft loss deduction of $300,000 that was claimed on his 2015 tax return. The taxpayer was unable to prove that a theft had actually occurred or that, if one had occurred, he had sustained the loss in 2015 as required by Sec. 165(e).

Baum case

Ronnie Baum and his wife, Teresa, resided in California when they filed their petition, as well as during the tax years in question. In 2010, Baum was in search of a new investment opportunity. He was invited by Scott Zeilinger to invest in a water purification business called Globe Protect Inc. In June 2012, Baum acquired 100,000 shares of Globe for $150,000. A week or so later, he acquired an additional 100,000 shares of Globe for an additional $150,000.

In 2014, Zeilinger filed for bankruptcy. Two of Zeilinger's creditors received a judgment in their favor in bankruptcy court in 2016, related to their ownership of shares in Globe. Zeilinger's bankruptcy case was finalized in 2019.

The Baums reported a theft loss deduction in the amount of $300,000 on their Schedule A, Itemized Deductions, which was attached to their 2015 federal income tax return. The couple asserted their losses were theft losses because Zeilinger had committed "fraud in inducement" by making false representations with the intent to defraud them of their investment in Globe.

Generally, in order to deduct a theft loss, a taxpayer must prove that a theft occurred under the law of the jurisdiction wherein the alleged loss occurred (Monteleone, 34 T.C. 688 (1960)). In California, fraud in the inducement falls into the category of theft by...