Are Fraud Losses Tax Deductible? IRS Rules and Exceptions

Fraud losses are generally not tax deductible when the money was lost in a personal scam, but they remain deductible when the fraud involved an investment, a business, or a Ponzi scheme. That split has been the rule since 2018, and Congress made the restriction on personal losses permanent in 2025. Whether your loss falls on the deductible or nondeductible side of the line comes down to one question: were you trying to earn a profit when you handed over the money?

Personal Scams Are No Longer Deductible

If a scammer talked you out of money in a context that had nothing to do with a business or an investment, the federal tax code offers no relief. The Tax Cuts and Jobs Act suspended the personal casualty and theft loss deduction for 2018 through 2025, and the One Big Beautiful Bill Act (P.L. 119-21) made that restriction permanent.¹ Someone who wires $15,000 to a phone scammer, loses money to a fraudulent online seller, or is taken in by a romance scam cannot use that loss to reduce taxable income.

A 2025 IRS Chief Counsel memorandum spelled this out directly for modern scam patterns: romance scams and fake kidnapping schemes do not qualify, because the victim was not trying to earn a profit when they sent the money.² The narrow exception carved out for federally declared disasters does not rescue fraud victims either: fraud itself is never a “disaster” under that provision.³

Investment Fraud: The Profit-Motive Exception

Fraud losses tied to a profit-seeking transaction operate under a different rule. Under Section 165(c)(2) of the Internal Revenue Code, a loss from a transaction you entered into for profit is deductible as a theft loss, and the permanent restriction on personal losses does not apply.⁴ An investor cheated by a fake hedge fund, a fraudulent cryptocurrency platform, or a Ponzi operator can still claim the deduction.

The 2025 IRS memorandum clarified how “profit motive” works with today’s scams. It does not require a conventional stock or bond purchase. If a scammer convinced you to move money under the false belief that you were protecting or growing it, you may qualify, because the test is whether you believed you were entering a transaction for financial gain.²

Three things have to be true to claim an investment theft loss:

The conduct qualifies as theft under the state law where it occurred.
You entered the transaction to make a profit.
You have no reasonable prospect of recovering the stolen funds.

You do not need a criminal conviction. The IRS asks only that the taking was illegal under applicable state law and was done with criminal intent.⁵ Investment theft losses also escape the per-event dollar floor and the 10% of adjusted gross income threshold that used to limit personal casualty losses.

Ponzi Scheme Losses: The Safe Harbor

Ponzi scheme victims can use a streamlined process under Revenue Procedure 2009-20, which the IRS created after the Madoff-era investment scandals. Rather than proving each element of theft on your own, you can use a formula the IRS has already blessed.⁶

To qualify, the arrangement must be a “specified fraudulent arrangement” in which a lead figure received investor money, reported fictitious income, and paid earlier investors with newer investors’ funds. The lead figure must also have been charged by indictment or criminal complaint with fraud, embezzlement, or a similar crime. If the lead figure died or fled before charges could be brought, the criminal conduct may still be established through other evidence.⁷

The deduction is calculated by taking your “qualified investment” (total cash you put in, minus everything you withdrew) and multiplying it by one of two percentages:

95% if you are not pursuing any third-party recovery, such as a lawsuit against a bank or brokerage that facilitated the scheme.
75% if you are pursuing or intend to pursue third-party recovery.

From that number you subtract any actual recoveries and any expected insurance or SIPC payments. The result is your deductible loss. The lower percentage builds in a reserve for money you might get back later.⁷

Business Fraud Losses

Theft losses that happen inside a trade or business were never affected by the personal loss restrictions. Employee embezzlement, a vendor’s fraud, or stolen business equipment is deductible as an ordinary business loss under Section 165(c)(1).⁵ These losses are not capped by the dollar floors or AGI thresholds that used to apply to personal losses.

When to Claim the Loss

You claim a theft loss in the year you discover the fraud, not the year the money actually left your account. This catches people off guard. If a financial advisor has been skimming since 2022 but you find out in 2026, the deduction belongs on your 2026 return.⁴

There is an important qualifier. You cannot take the deduction while you still have a reasonable prospect of recovering the money. If you have filed a lawsuit and the outcome is genuinely uncertain, you may need to wait until the litigation resolves or recovery becomes clearly unlikely.² The Ponzi safe harbor sidesteps this problem by letting you take 75% of the loss immediately, even while pursuing recovery.

Documentation You Will Need

The IRS will not accept a fraud loss on your say-so. You need records proving both the amount and the criminal nature of the loss. Gather:

A police report or FBI IC3 complaint documenting the fraud. Failing to report the theft to law enforcement can be grounds for the IRS to deny the deduction outright.
Bank statements, wire transfer receipts, brokerage statements, and correspondence with the fraudster showing how much you paid or invested.
Adjusted basis records: original cost of the property, plus improvements, minus any depreciation already claimed.
Evidence of any insurance payouts, SIPC distributions, court-ordered restitution, or settlements. These reduce the deductible loss dollar for dollar.
Anything that establishes when you first learned of the fraud, since the discovery date fixes which year the deduction belongs to.⁸

Ponzi safe harbor users also need a full history of cash in and cash out over the life of the arrangement, because the qualified investment calculation depends on it.

How to Report the Loss

Form 4684, Casualties and Thefts, is where every fraud loss claim starts. Section B covers business and income-producing property. Section C is specifically for Ponzi scheme victims using the Revenue Procedure 2009-20 safe harbor: enter your total investment, subtract withdrawals, apply the 95% or 75% multiplier, and carry the result into Section B.⁹

Where the number goes after Form 4684 depends on the property. Investment property losses flow to Schedule A. Business property losses flow to Form 4797.¹⁰ For large or complex claims, expect the IRS to follow up with a request for additional verification of the theft or the property basis.

If You Recover Money Later

If you claim a theft loss and then recover some or all of the funds through insurance, a settlement, or restitution, you generally report the recovered amount as income in the year you receive it. Under the tax benefit rule, a deduction that reduced your tax in a prior year makes the later recovery taxable when it arrives. You do not amend the old return; you include the recovery on the return for the year the money comes in.

Ponzi safe harbor users who took the 75% figure have already built a cushion for expected recoveries into the math. Only recoveries that exceed what the safe harbor assumed need to be reported as income in the year received.

1
Internal Revenue Service. Casualty Loss Deduction Expanded and Made Permanent
2
Internal Revenue Service. IRS Chief Counsel Advice on Theft Loss Deductions for Scam Victims and What It Means for Taxpayers
3
Congress.gov. The Nonbusiness Casualty Loss Deduction
4
Office of the Law Revision Counsel. 26 U.S. Code 165 – Losses
5
Internal Revenue Service. Topic No. 515, Casualty, Disaster, and Theft Losses
6
Internal Revenue Service. Help for Victims of Ponzi Investment Schemes
7
Internal Revenue Service. Revenue Procedure 2009-20
8
eCFR. 26 CFR 1.165-8 – Theft Losses
9
Internal Revenue Service. Form 4684 – Casualties and Thefts
10
Internal Revenue Service. Instructions for Form 4684