Recent guidance from the Internal Revenue Service will enable more taxpayers suffering losses from investment schemes (such as those perpetrated by Bernard Madoff and Robert Stanford) to claim such losses on their 2008 tax returns.
Safe Harbor for Reporting Such Losses
The IRS guidance makes clear that losses from investment schemes are properly considered ``theft`` losses, resulting in ordinary losses reportable on an individual investor`s Schedule A to the 1040. However, because of the difficulty in applying certain aspects of the rules (namely related to determining the amount that is deductible in the year discovered), the IRS guidance provides an optional safe harbor under which certain investors may report a theft loss in the year discovered, without having to determine either the full amount of such losses incurred or the taxpayer`s likely prospects of recovering any such losses. Among certain other requirements, for a taxpayer to rely on the safe harbor, the perpetrator of the investment scheme must be the subject of a state or federal criminal complaint alleging such a crime.
The safe harbor provides that a loss from an investment scheme is deductible up to either 95 percent of the loss, if no recovery is being sought, or 75 percent of the loss, if any third party recovery is sought, provided certain procedural and eligibility requirements are satisfied. If the taxpayer obtains a recovery in a future year, then the taxpayer may be required to recognize income (or report additional losses) in such future year.
Accordingly, taxpayers that have suffered a loss from an investment scheme should carefully consider the application of this recently issued IRS guidance in determining the timing and amount of any theft loss incurred, including whether they are entitled to rely on the safe harbor described above. As the theft loss may be eligible for 2008 recognition, it is important that any potentially eligible taxpayers consider the applicability of this guidance promptly.