Code Section 165 Background

General Rule | There shall be allowed as a deduction any loss sustained during the taxable year not compensated for by insurance or otherwise.

Amount of Deduction | For purposes of subsection(a) the basis for determining the amount of the deduction for any loss shall be the adjusted basis.

Limitation on Losses of Individuals | In the case of an individual taxpayer, the deduction permitted by Code Section 165 is limited to:

• losses incurred in a trade or business,
• losses incurred in any transaction entered into for profit, though not connected with a trade or business,
• losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty or form of theft.

Theft Losses | For the purposes of subsection(a) any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers the loss. However, if in the year the theft loss is discovered, there exists a claim for reimbursement for which there is a "reasonable prospect of recovery" then no amount of the loss may be deducted until the year in which it can be ascertained with reasonable certainty whether or not such reimbursement will be received.

Benefits | The theft loss deductions permitted by Code Sections 165(c)(2) and (c)(3) offer several important advantages over other deductions that are available to individual taxpayers:

• A theft loss deduction is an ordinary deduction that is not subject to the limitations on capital losses imposed by Code Section 1211.
• A theft loss deduction is not a miscellaneious itemized deduction subject to the 2% floor imposed by Code Section 67(a).
• A theft loss deduction is excluded from the phase out of itemized deductions required by Code Section 68.
• A theft loss deduction that exceeds a taxpayer's gross income gives rise to a "net operating loss" that is not subject to the limitations imposed on non-business deductions of individual taxpayers Code Section 172.
• A theft loss deduction can be used to reduce a taxpayer's tax liability to zero without resulting in any liability for AMT Code Section 56.

Basis for Theft Loss Deduction | The taxpayer must be able to demonstrate the following to pursue a theft loss deduction:

• Loss due to theft, larceny, embezzlement, robbery. Note, if a transaction did not amount to theft in the State where the loss was sustanted, the Code Section 165(c)(2) does not apply.
• Amount of Loss - the adjusted basis of investment. Note, victims are not entitled to unrealized appreciation and/or profits.
• Year in which the loss can be deemed uncollectible. Note, there needs to be no reasonable prospect of recovery for the loss to be deductible.

If any of this information seems overwhelming, do not worry, you are NOT alone. Tax Relief, Inc. is here to assist you and help determine if your individual circumstances justify pursuit of a theft loss deduction. To discuss your individual circumstances, you or your representative should contact us for a free consultation.

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