The tax law allows you to deduct your personal losses resulting from casualties and thefts within certain limits. And a "theft" for tax purposes isn't strictly limited to house burglaries or stolen cars. However, as you will see from several U.S. Tax Court cases, the deduction can hinge on the application of state law.
The tax law definition of theft can include the taking of money or property by:
Deductions for theft cannot be taken in many cases including when:
Basic ground rules: If you suffer a casualty or theft loss, you generally may deduct the amount of your unreimbursed loss only to the extent that your losses for the year exceed 10% of your adjusted gross income (AGI) for the year. (Special rules apply to losses in federal disaster areas. Before the 10% limit is applied, you must subtract $100 for each casualty or theft occurrence.)
The deductible amount must also be reduced by any insurance reimbursements.
For simplicity, let's say that your annual AGI is $100,000. In February, a severe winter storm causes $20,100 of damage to your home. Your wallet with $200 is stolen from your gym locker in June. Finally, you have a fender-bender in September that sets you back another $1,000. The insurance reimbursements for the year total $6,000.
On these facts, your deductible casualty and theft losses add up to $15,000 after the amount is reduced by insurance and $100 is subtracted for each occurrence [($20,000 plus $100 plus $900 equals $21,000) minus $6,000 equals $15,000]. So you can deduct $5,000 on your tax return after the 10% limit is applied ($15,000 minus $10,000)
A theft loss is deductible in the year it is discovered. How is a "theft" defined for tax purposes? It is the taking of money or property with the intent to deprive the owner of it (see right-hand box). But that's not all: The taking must be illegal in the state where the incident occurred and it must have been conducted with criminal intent.
One court case: A husband and wife contracted to have a $190,000 house built in New Mexico by a contractor. After they moved in, the couple began noticing problems with the house. These problems escalated and became a "living nightmare," according to court documents, despite the repair efforts of the contractor and several subcontractors.
Eventually, the taxpayers claimed a theft loss of $172,000 relating to poor construction and misrepresentations made by the contractor. This resulted in a refund of $10,225 on their amended tax return.
Under New Mexico law, fraud is defined as "the intentional misappropriation or taking of anything of value that belongs to another by means of fraudulent conduct, practices or representations." The elements of criminal fraud include a specific intent to cheat or deceive another person.
The taxpayers argued they were entitled to a theft loss deduction on the basis that the contractor committed "fraud" under New Mexico law. "In essence, they contend that (the contractor) took money from them intending not to conform with the plans that he had agreed to follow in constructing their house," court documents state.
However, based on the facts, the court determined that no crime was committed. Reason: The contractor did not defraud the taxpayers by misrepresenting his qualifications. The claims he made were in the nature of "sales talk" or puffery. In the end, the taxpayers were mere victims of poor workmanship. This was certainly unfortunate for them, but not illegal. Therefore, they could not deduct the theft loss. (TC Memo 2007-366)
The court noted that the case was "not novel." The court has addressed similar home construction issues on many occasions but generally rules against taxpayers on the basis that they have not proven that the "contractors acted with the requisite intent to constitute a theft crime."
In the cases in which the Tax Court has allowed theft loss deductions, contractors "took money from taxpayers under false pretenses and then either absconded or ceased construction and used the money for purposes not related to the construction agreement," the court added.
Here are four other cases involving taxpayers who successfully and unsuccessfully claimed theft loss deductions:
It is important to investigate state law to determine if a crime has actually been committed. Consult with your tax advisor on how to proceed.
If your business received a PPP loan, you may be eligible to have that loan forgiven. Our team can help you ensure that your loan forgiveness application is filed correctly and timely. Complete our five-question form, and we can provide a quote for your application by the next business day.Request a Quote