Can I Deduct the Money That I Sent to (or Was Stolen by) a Scammer?

By: Matthew E. Foreman, Esq., LL.M. and Tonya L. Hurd

It’s probably safe to say that anyone with a cell phone or an email account has been the target of a scam, such as phishing, smishing, or quishing.[1] The scammers, disguised as bank employees, too-good-to-be-true investment opportunities, or a loved one in a sticky situation, contact individuals attempting to induce the target to transfer funds from their bank accounts or retirement accounts. The scammer secures the funds and disappears, leaving the victim literally and figuratively at a loss.

The prevalence of these scams has prompted the Internal Revenue Service to issue Chief Counsel Memorandum 202511015 (the “CCM”)[2] to explain the tax consequences, specifically the question whether losses incurred as a result of a variety of scams are deductible theft losses under section 165 of the Internal Revenue Code (the “Code”). Five common scam scenarios are addressed in the memo, which concludes that losses incurred in transactions entered into profit are deductible under section 165(c)(2), and losses that are incurred in transactions not entered into for profit may still be deductible as theft losses under section 165(c)(3). However, in taxable years 2018 through 2025, deductions for such casualty losses are not allowed to the extent of personal casualty gains unless attributable to a federally declared disaster.[3]

Losses Under the Internal Revenue Code

Section 165 of the Code allows as a deduction for any loss sustained during the taxable year that is not compensated for by insurance or otherwise.[4] For individuals, the deduction is available when the loss was incurred (1) in a trade or business; (2) in a transaction entered into profit but not connected to a trade or business; or (3) for losses incurred in a taxable year that includes December 31, 2017, as a result of a casualty or theft.[5]

A transaction is entered into for profit when the transaction has a primary profit motive.[6] Scams that are based on investment opportunities have fairly obvious profit motives, but other scams involving the simple transfer of funds from existing investment accounts into new investment accounts (often because the scammer says the existing account is “compromised”) are also considered as being entered into for profit.[7]

If the loss was incurred as a result of theft, the taxpayer must establish that the loss resulted from an illegal taking of property done with criminal intent that is considered theft under applicable state law.[8] The deduction is available for theft losses in the year in which the taxpayer discovers the loss;[9] however, if there is a reasonable prospect of recovering the loss at the close of the tax year, then a loss has not been sustained and the loss is not deductible.[10] A reasonable prospect of recovery exists when the taxpayer has bona fide claims for recoupment against a third party, and there is a substantial possibility[11] that such claims will be decided in the taxpayer’s favor.[12] Scams resulting in theft often involve the taxpayer transferring sums of money as gifts to scammers posing as romantic partners or as ransom to scammers orchestrating a fake kidnapping of the taxpayer’s loved one.

The amount of the loss deduction is limited to the taxpayer’s adjusted basis in the property, which is usually the amount the taxpayer paid for the property.[13] When the balance of a retirement or investment account is transferred, this limitation permits a deduction only to the amount of the taxpayer’s initial investment, as any income or unrealized gain from that investment is not allowed to be deducted.[14]

The Scams

Compromised Account

Compromised account scams occur when the victim is contacted by someone pretending to be a “fraud specialist” from the victim’s financial institution. The scammer will convince the victim that their computer and/or bank accounts have been compromised, and that there were attempts made to withdraw funds. The scammer convinces the victim to transfer funds from the financial account to a new account created and controlled by the scammer. The scammer transfers the funds from the new account to another bank account, often overseas, over which the scammer has control. The victim’s motive for transferring the money is usually to safeguard and reinvest all of the funds into new accounts. Generally, there is little to no prospect of recovery, and therefore the taxpayer is entitled to deduct the loss as being incurred in a transaction entered into for profit.[15]

Pig Butchering

A pig butchering investment scam refers to the way in which scammers will “fatten up” an account before stealing its funds by promising, and often delivering,[16] large investment returns, usually in cryptocurrencies, to persuade the victim to deposit money into accounts on seemingly legitimate websites. The scammers will allow the victim to make money and withdraw some of the profits, earning their trust and incentivizing the victim to invest larger and larger sums of money into the scheme. At some point, the scammer will transfer the funds or act as a counterparty to the victim,[17] leaving the victim with nothing more than an empty account or an error message. The victim of a butchering investment scam’s motive is to earn profit; therefore, a taxpayer who loses money in this way is entitled to deduct their loss.

Phishing

Phishing scams convince the victim that the victim’s accounts have been compromised. Often, the initial contact comes as an unsolicited email or text message from the scammer, including instructions for protecting the victim’s funds. By following the instructions, which often include a link to click, the victim grants the scammer remote access to their computer, phone, etc., allowing the scammer to access personal account and password information, enabling the scammer to access the accounts and transfer the funds to their own overseas bank account. In phishing scams, the victim doesn’t transfer any money themselves, so the motive that is determinative of the loss’s deductibility comes from the nature of the funds themselves: If the funds were held in an investment account, then they are deemed to have a profit motive.[18] However, if the funds were in a bank account that earned no interest, then they will be classified as stolen personal property.[19] The distinction may seem hollow, but it is important for losses occurring in taxable years 2018-2025 as funds held in a bank account are a casualty loss and therefore not deductible.

Romance Scam

A romance scam uses a virtual romantic relationship, usually initiated by an unsolicited text message or message on a social media platform.[20] The scammer, exploiting the victim’s romantic interest, will convince the victim to transfer money into an overseas account. Often the victim will use funds from retirement accounts to make the transfer. Even though those funds had a profit motive, the victim’s motive in entering into the transaction was not profit.[21] Therefore, a victim of a romance scam suffers a casualty loss and cannot deduct the amount if the loss was incurred in taxable years 2018-2025. Additionally, if the funds were distributed from an IRA account, the taxpayer must recognize gain or loss on the disposition of assets to a non-IRA account.[22]

Kidnapping Scam

Using extreme duress, a kidnapping scam is when the victim is convinced that a loved one has been kidnapped and held for ransom. Scammers will use artificial intelligence to clone the loved one’s voice, legitimizing the threat and creating a sense of urgency. The victim will transfer assets from a bank account or retirement account to satisfy the demands. Like the romance scam, there is no profit motive, and therefore any losses incurred in a kidnapping scam are casualty losses and not deductible if incurred in taxable years 2018-2025.

Conclusion

If you or someone you know has lost money in these or other scams, filing a complaint with the local police or FBI might not be the end of the story. A knowledgeable tax attorney can help to minimize the financial impact of scams by evaluating the facts of your case to determine if you are eligible to deduct some or all of the amount from your taxable income. It’s important to act quickly, because any deduction you may qualify for as a result of such loss is only available in the taxable year of which it was incurred.

For guidance on potential deductions or other tax-related matters, contact FRB’s Taxation Practice Group at (516) 599-0888 or fill out the form below. 

[1] Despite the absurdity of these names, we assure you that they are very much real things.

[2] C.C.A. 202511015 (Jan. 17, 2025).

[3] I.R.C. § 165(h)(5).

[4] Though not defined explicitly, “otherwise” is generally understood to be non-insurance reimbursement of some sort.

[5] I.R.C. § 165(c).

[6] I.R.C. §§ 162 and 183; Treas. Reg. § 1.183-2(b); Comm’r v. Groetzinger, 480 U.S. 23 (1987).

[7] C.C.A. 202511015 (Jan. 17, 2025).

[8] See Rev. Rul. 2009-9, 2009-14 I.R.B. 735 (April 6, 2009); Vennes v. Comm’r, T.C. Memo. 2021-93 at *28-*29.

[9] I.R.C. § 165(e).

[10] Treas. Reg. §§ 1.165-1(d)(2), 1.165-1(d)(3), and 1.165-8(a)(2); Rev. Rul. 2009-9, 2009-1 C.B. 735; Vennes v. Comm’r, 122 T.C.M. (CCH) 95, at *34-*35.

[11] Treas. Reg. § 1.165-1(d)(3).  It must be noted that a “substantial possibility” is synonymous with a “reasonable prospect of recovery” and not merely any possibility, as there must be a realistic possibility of recovery.  Ramsay Scarlett & Co. v. Comm’r, 61 T.C. 795 (1974), aff'd, 521 F.2d 786 (4th Cir. 1975) (reasonable prospect of recovering embezzlement loss from bank); Jeppsen v. Comm’r, 128 F.3d 1410 (10th Cir. 1997) (pursuit of available legal remedies established reasonable prospect of recovery despite impediments to lawsuit); Premji v. Comm’r, 139 F.3d 912 (10th Cir. 1998) (bankruptcy trustee indicated recovery of assets was possible); CCA 200725031 (factors to consider in determining reasonable prospect of recovery).

[12] Ramsay Scarlett & Co. v. Comm’r, 61 T.C. 795, 811 (1974), aff’d, 521 F.2d 786 (4th Cir. 1975).

[13] I.R.C. § 165(b).

[14] Id.

[15] C.C.A. 202511015 (Jan. 17, 2025).

[16] These returns are often illusory, as the scammers often use closed markets or altogether false transactional records.

[17] Essentially, the scammer will convince the victim to enter into one final trade where the victim is “rekt,” in crypto parlance, with the scammer being the counterparty on the better side of the trade.

[18] C.C.A. 202511015 (Jan. 17, 2025).

[19] Id.

[20] These are also initiated through legitimate websites and apps.

[21] C.C.A. 202511015 (Jan. 17, 2025).

[22] I.R.C. §§ 72 and 408(d). An additional 10% early withdrawal penalty may be imposed under I.R.C. § 72(t).

DISCLAIMER: This summary is not legal advice and does not create any attorney-client relationship. This summary does not provide a definitive legal opinion for any factual situation. Before the firm can provide legal advice or opinion to any person or entity, the specific facts at issue must be reviewed by the firm. Before an attorney-client relationship is formed, the firm must have a signed engagement letter with a client setting forth the Firm’s scope and terms of representation. The information contained herein is based upon the law at the time of publication.