You Lost Your Money On a Scam, Will Uncle Sam Help? | USTaxAid

Diane Kennedy's Blog

You Lost Your Money On a Scam, Will Uncle Sam Help?

Written by Diane Kennedy, CPA on November 13, 2021

One of the questions I’m seeing pop up frequently, unfortunately comes from victims of scams. Sometimes the scams are bad investments. Sometimes they are from victims of unscrupulous promoters who promised everything and delivered nothing. And sometimes they are from people who were truly the victim of crimes.

I received this question recently at Tax Questions.

“I invested $28K in commercial property new construction as part of a group in 2018. COVID happened. The property was finally sold at a loss and I lost money. Some of the investors hired an attorney, and there is no recourse for us.”

That’s the edited version of the longer question.

In this case, there are some initial things we would need to know.

(1) Was the money lent to a project or person or was an investment made into a business structure? (i.e., a limited partnership interest in a limited partner or other type of business structure)

(2) If the money was lent, was this from you personally or was it through a regular business transaction? 

(3) Is the amount of the loss certain and complete?

(4) If there will be criminal charges, at what stage are you in that process? Pending charges? Already sentenced? Or?

There will likely be more questions, but let’s start with those and the significance of them.

(1) If you make an investment that shows a loss on the K-1 you receive, then you need to determine what type of partner/member/shareholder you are.

If it’s passive, the passive loss rules apply. And if you are a limited partner in a limited partnership or member with no management responsibilities in a manager-managed LLC, you have passive losses no matter what. Even being a real estate professional won’t change the character.

In an S Corporation, you may be able to take the loss. It would depend on whether you actively participated in the investment or businesses or not.

If the business sold the assets and closed down, you will have an ordinary gain or loss and/or capital gain or loss. A capital loss is deductible up to the amount of capital gains that you have plus $3,000 per year. You’ll need to wait until year-end to see how the gain or loss will be characterized on your K-1. Alternatively, you could have your CPA contact their accountants to discuss the details. (Assuming there is still someone around at the failed investment to talk to.)

(2) Since 2018, we’ve lost the deduction for personal bad debts. If you have a business that makes a loan in the course of business, the business can likely take the write-off.

For example, if you loan your Uncle Harry $5,000 and he stiffs you, you don’t get a write-off. If your business sells some inventory to a customer and then doesn’t pay for it, you do have a write-off.

If in case of question (1), if it was a loan to some builders that you made personally, you probably don’t have a write-off. 

(3) In order to take a loss deduction, either ordinary or capital, you need to know the amount of the loss. If you’re in the middle of litigation, you likely don’t know how much your loss will be, so nothing is deductible yet.

The legal cases need to be settled and then you can take a loss, if you still have one after the settlements are done, in the current year of your tax return. 

(4) What if there are criminal charges? 

This is an interesting question. Back in 2009, the so-called “Bernie Madoff tax deduction” was enacted. This applied to certain victims of Ponzi schemes in which the perpetrators faced criminal charges.

The important part of this for victims is that an investor who has been taken in by a Ponzi scheme can take a deduction for the lost funds as a theft loss instead of as a capital loss, which is subject to restrictions. 

The safe harbor rules for determining whether you have a Bernie Madoff deduction include 3 conditions. 

  1. The promoter was charged under state or federal law with fraud, embezzlement or similar crime, or
  2. The promoter was the subject of a state or federal criminal complaint alleging commission of a similar crime AND
  3. There was either an admission of guilt or a trustee was appointed to freeze the assets of the scheme. 

The Tax Cuts and Jobs Act (Trump Tax Plan) did away with theft and casualty losses, so that has created some confusion. Are Ponzi scheme losses no longer deductible? 

The answer is in the instructions for Form 4684 (Casualties and Thefts form). Personal losses became nondeductible under the Trump Tax Plan. But “for profit” losses were still valid. The Revenue Ruling 2009-9, which allowed the Bernie Madoff write off for victims of his and like schemes, states specifically that these are considered losses arising from transactions entered for profit.

Bottomline, if you are the victim of a Ponzi scheme, you can still get a write off. I don’t wish this type of fraud on anyone, but at least Uncle Sam can help you a little.

I did a quick Google search to see what other sites are talking about regarding the write offs and predictably, I saw a lot of bad information. 

Be careful who you get tax advice from, including this site. You can go back to old blogs and find information that is no longer valid. And you can find advice that is specific for a particular set of circumstances that won’t apply to you.

Free advice, especially online advice on social media, can be the most expensive advice you ever get.

Got a tax question? You can ask it here, but the best answers will come with a personalized consultation or even through our Wednesday Coaching classes. It’s a very affordable way to learn a lot about taxes and how to legally use tax law to your advantage. 

Leave a Comment


  • Three weekly emails with free tax updates
  • Exclusive deals on products and services
  • FREE Video: How to Write Off Practically Anything