Americans lose billions of dollars every year to financial scams. Investment fraud, cryptocurrency schemes, fake trading platforms, impersonation scams, and increasingly sophisticated online fraud can wipe out savings remarkably quickly.

When that happens, victims naturally ask a tax question:

Can money stolen through a scam be deducted on your federal income tax return?

The surprising answer is sometimes.

The federal tax treatment of scam losses depends heavily on why the taxpayer transferred the money. A taxpayer who loses money while attempting to make an investment may be treated very differently from someone who transfers money to a scammer for purely personal reasons.

The distinction comes primarily from Internal Revenue Code § 165 and the Treasury Regulations governing theft losses.

IRC § 165 Generally Allows Deductions for Certain Losses

Section 165(a) begins with a remarkably broad rule:

“There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.”

For individuals, however, the statute substantially narrows that general rule. Among the categories potentially deductible are losses incurred in a trade or business and losses incurred in a “transaction entered into for profit.”

That second category can become extremely important for victims of investment scams.

Suppose someone convinces a taxpayer that he operates a profitable cryptocurrency investment platform. The taxpayer transfers $75,000 believing the money will be invested. The website subsequently disappears and the supposed investments never existed.

Although the transaction was fraudulent, the taxpayer transferred the money because he expected to earn a profit.

That fact can make a major difference under § 165.

What Counts as a “Theft” for Federal Tax Purposes?

Treasury Regulation § 1.165-8 provides specific rules for theft losses.

The regulation gives the term a relatively broad meaning:

“the term ‘theft’ shall be deemed to include, but shall not necessarily be limited to, larceny, embezzlement, and robbery.”

Treas. Reg. § 1.165-8(d). (Legal Information Institute)

The IRS further explains that theft generally involves taking money or property with the intent to deprive its owner of it, and that the conduct must constitute theft under the law applicable where it occurred. Fraud or misrepresentation can constitute theft when the conduct satisfies applicable state or local criminal law. (IRS)

Accordingly, merely making a terrible investment is not necessarily a theft.

If you invest $50,000 in a legitimate company and the company fails, you generally cannot transform your investment loss into a theft loss simply because management made bad decisions.

Fraud presents a different question.

The IRS Has Specifically Addressed Modern Financial Scams

This subject became considerably more interesting after the IRS Office of Chief Counsel released Chief Counsel Advice Memorandum 202511015 in March 2025.

The memorandum specifically considered taxpayers victimized by several forms of scams and analyzed whether their losses could qualify under § 165. (IRS)

The IRS’s current Publication 547 summarizes the resulting framework. A victim of a financial scam may potentially claim a theft loss deduction when:

1. the loss results from criminal conduct constituting theft under applicable law;
2. there is no reasonable prospect of recovering the stolen funds; and
3. the loss arises from a transaction entered into for profit. (IRS)

That third requirement creates one of the most important—and perhaps least intuitive—distinctions in the tax treatment of scam victims.

Investment Scam Versus Personal Scam

Imagine two taxpayers each lose $100,000.

Taxpayer A meets someone online who claims to operate an extraordinarily profitable investment program. A transfers $100,000 believing it will be invested and generate returns. The entire operation turns out to be fraudulent.

Taxpayer B receives a telephone call from someone impersonating a government official. The caller falsely threatens B with arrest unless B immediately transfers $100,000.

Economically, both taxpayers lost the same amount.

For tax purposes, however, their situations may be very different.

Taxpayer A arguably entered the transaction for profit. Taxpayer B did not. The purpose of B’s payment was personal—avoiding the threatened consequence—not earning money.

The Taxpayer Advocate Service has specifically noted this distinction, explaining that some scams involving a profit motive can potentially generate deductible theft losses while purely personal scams may not. (Taxpayer Advocate Service)

“Pig Butchering” and Fake Investment Platforms

One increasingly common form of fraud illustrates the issue particularly well.

A scammer develops a relationship with a victim and eventually persuades the victim to place money into what appears to be an investment account. A website or application may even display fictitious profits.

The victim invests additional money because the supposed investment appears successful.

Eventually, withdrawals become impossible and the victim discovers that there was never a legitimate investment.

The critical tax issue is not simply that the victim was defrauded. It is whether the victim entered the transaction with an actual profit motive.

The IRS Chief Counsel memorandum analyzes several scam scenarios through precisely this framework. (IRS)

When Is a Theft Loss Deducted?

Another unusual feature of theft losses involves timing.

Treasury Regulation § 1.165-8(a)(2) provides:

“A loss arising from theft shall be treated under section 165(a) as sustained during the taxable year in which the taxpayer discovers the loss.”

That means the relevant tax year ordinarily is the year the theft is discovered, rather than necessarily the year in which the money was originally stolen. (Legal Information Institute)

But there is another complication.

If the taxpayer has a reasonable prospect of recovery, the deduction may have to wait.

For example, suppose a taxpayer discovers in 2026 that $200,000 was stolen through an investment fraud, but authorities have frozen accounts containing most of the stolen money and the taxpayer has a substantial reimbursement claim.

The taxpayer cannot simply assume that the entire $200,000 is permanently lost.

The prospect of recovery must be considered.

What Is a “Reasonable Prospect of Recovery”?

Treasury Regulation § 1.165-1 generally ties the determination to the facts and circumstances.

This can become important where there are:

• insurance claims;
• bankruptcy proceedings;
• receiverships;
• restitution orders;
• pending litigation; or
• funds seized by law enforcement.

The mere theoretical possibility that the taxpayer might someday recover something does not necessarily postpone the deduction forever. But taxpayers also cannot claim a loss while ignoring a meaningful reimbursement claim.

The IRS likewise explains that theft losses are generally deductible in the year discovered unless there is a reasonable prospect of recovery through a claim for reimbursement. (IRS)

How Much Is the Theft Loss?

Treasury Regulation § 1.165-8(c) directs taxpayers to determine the amount of a theft loss consistently with the casualty-loss valuation rules of Treasury Regulation § 1.165-7.

The theft regulation treats the property’s fair market value immediately after the theft as zero. (Legal Information Institute)

Treasury Regulation § 1.165-7(b)(1), in turn, generally measures the relevant loss using the lesser of the decline in fair market value or the taxpayer’s adjusted basis in the property. (Legal Information Institute)

For stolen cash, the analysis is relatively straightforward.

Other property can be more complicated.

And amounts subsequently recovered through insurance, restitution, settlements, bankruptcy distributions, or other sources may affect the deductible amount.

Losing Money in the Stock Market Is Not Automatically Theft

This distinction deserves special attention.

Suppose you purchase shares of a publicly traded corporation for $50,000. The company’s officers later turn out to have committed accounting fraud, the share price collapses, and your investment becomes nearly worthless.

That does not automatically mean that you suffered a theft loss.

IRS guidance has distinguished between money actually appropriated from an investor through a fraudulent arrangement and an ordinary investment whose value collapses because corporate officers engaged in misconduct. In the latter situation, the taxpayer may instead have a capital-loss or worthless-security issue. (IRS)

That distinction can dramatically affect the tax consequences.

What About Ponzi Schemes?

Ponzi schemes have their own substantial body of IRS guidance.

Revenue Ruling 2009-9 addresses losses from certain fraudulent investment arrangements, while Revenue Procedure 2009-20 created a safe-harbor procedure for qualifying Ponzi-scheme victims. Publication 547 continues to direct taxpayers to those authorities. (IRS)

But not every online scam qualifies for the Ponzi safe harbor.

A taxpayer might potentially have a deductible theft loss under ordinary § 165 principles without satisfying the special requirements applicable to the Ponzi-scheme safe harbor.

That distinction is important because taxpayers sometimes assume that a scam must technically constitute a Ponzi scheme before any theft deduction is possible.

It does not.

Retirement-Account Scams Can Be Especially Painful

One particularly harsh situation occurs when scammers persuade victims to withdraw money from an IRA or 401(k).

Imagine that a taxpayer withdraws $150,000 from an IRA because a scammer promises to invest it.

The taxpayer may have two separate tax problems.

First, the IRA distribution may constitute taxable income.

Second, depending on the taxpayer’s age and circumstances, an additional tax on an early distribution may apply.

The fact that the money was immediately stolen does not automatically undo the retirement-account distribution. The Taxpayer Advocate Service has specifically highlighted this problem: scam victims can lose their savings and still face tax consequences from withdrawing the money that was stolen. (Taxpayer Advocate Service)

A qualifying theft-loss deduction may help in some circumstances, but it does not necessarily erase every tax consequence associated with the distribution.

Documentation Matters

A substantial theft-loss deduction should not be approached casually.

A taxpayer should preserve evidence showing both what happened and why the transaction was undertaken.

Relevant documentation might include communications with the scammer, bank and brokerage records, cryptocurrency transaction records, screenshots of the purported investment platform, police reports, complaints submitted to government agencies, documents concerning attempted recovery, and evidence showing that the taxpayer believed the transaction was an investment.

That last category can be particularly important.

When deductibility depends upon whether the transaction was entered into for profit, contemporaneous evidence showing an investment motive may become highly relevant.

The Tax Law Draws an Uncomfortable Distinction Between Scam Victims

The federal tax rules can produce a strange result.

Two people may each lose their entire life savings to criminals.

One may potentially receive a substantial federal income tax deduction because the criminal induced the victim to enter an apparent investment.

The other may receive no comparable deduction because the criminal used fear, romance, impersonation, or some other personal motivation.

From the victims’ perspective, the financial damage may be identical.

From the Internal Revenue Code’s perspective, however, the character and purpose of the transaction matter.

That is why taxpayers who have suffered substantial fraud losses should not automatically conclude either that the loss is deductible or that it is not.

The answer can turn on surprisingly technical distinctions involving § 165, applicable state theft law, the taxpayer’s profit motive, the year the loss was discovered, and the likelihood that some portion of the money will eventually be recovered.

Bottom Line

Money lost to a scam is not automatically deductible.

But certain financial scams—particularly fraudulent transactions that taxpayers entered into with a genuine expectation of earning a profit—may potentially produce deductible theft losses under IRC § 165(c)(2).

Treasury Regulation § 1.165-8 provides the basic federal rules for theft losses, while recent IRS guidance gives taxpayers and practitioners a clearer framework for analyzing modern investment scams.

The critical questions are often:

Was there legally a theft? Was the transaction entered into for profit? When was the theft discovered? And was there a reasonable prospect of recovering the money?

For someone who has lost tens or hundreds of thousands of dollars to financial fraud, the answers can have enormous federal income tax consequences.

This article is for general informational purposes only and does not constitute legal or tax advice. The federal tax treatment of theft and scam losses is highly fact-specific, and taxpayers should obtain professional advice concerning their particular circumstances.

I like this one quite a bit, bro. Haha. It hits a very contemporary public-interest problem, fills a genuine hole in your index, and has enough technical machinery underneath it—§ 165(c)(2), Treas. Reg. §§ 1.165-1, 1.165-7, and 1.165-8, plus the 2025 Chief Counsel memorandum—that it isn’t just another generic “what happens if I get scammed?” article.

At Dino Tax Co, we help clients navigate tax matters ranging from unfiled returns to IRS letters and levies and everything in between with clarity and confidence. If you’d like guidance on your situation, schedule a consultation today. Call or text (713) 397-4678 or email davie@dinotaxco.com. We’re here to help you take the next step.