#1) Taxable Cost Basis
You cannot deduct as a Section 165 (c) (2) Casualty any funds that were not previously taxed before being lost. In other words, no IRA losses or pension losses are allowable. (Inherited funds are eligible.)​

#2) Previous Deduction
Many cases require the adjustment of the amount that can be claimed as a Section 165 casualty. If you have previously recorded your loss as a capital loss, any amount that already derived a tax benefit must be subtracted. In other words, if you listed a USA Capital $100,000 loss as a capital loss in the past; the loss may already be completely deducted and there is no remainder to take as a casualty. It is also possible that you may simply be deducting the ‘excess capital loss deduction of $3,000 per year’. If you have been deducting $3,000 per year, each of those deductions must be subtracted. So after 10 years (10 x $3000 = $30,000) you would only have $70,000 of your remaining uncollected losses available as a present deduction.

#3) Previous Deduction as a Casualty Loss

​​There are a few possibilities for this question:
     a) Losses previous deducted under the ‘legacy’ rules of a Section 165 Theft Loss
     b) Losses previously deducted under the “Safe Harbor Methodology’.
     c) A combination of both a) and b)

a) Losses previous deducted under the ‘legacy’ rules of a Section 165 Theft Loss
Any loss that was previously deducted using the law that existed before the Bernard Madoff Ponzi scheme (before revenue ruling 2009-9 and revenue procedure 2009-20 and subsequent rulings and procedures related to the safe harbor methodology) cannot be used again. Under that law, any amount that was considered not to have any reasonable prospect of recovery would have been taken in entirety.

b) Losses previously deducted under the “Safe Harbor Methodology’.
In order to clear any confusion regarding the “Year of Discovery” (the proper year for taking a Section 165 loss). Congress passed laws that allowed USA Capital victims to take all of their losses as a cumulative lump sum against their 2009 income (on their 2009 tax return). Once the lump sum was calculated, depending on what efforts the investors were are part of for recovering their money; the taxpayer was allowed to take a Section 165 loss equal to 95% or 75% of their cumulative losses as an immediate loss. (95% = only bankruptcy proceedings / 75% = participation in a third party litigation [a lawsuit]).

If you claimed a Safe Harbor Theft Loss; careful review and calculation must be taken to avoid the loss of any potential deduction of the remainder (the remaining un-deducted 5% or 25%). This is probably too complicated to cover at length here.

THE PROBLEM with the safe harbor deductions was that in order to ‘write-off’ the un-deducted 5% or 25%; the taxpayer needs to wait until the resolution of the last collection effort for any of the loans lumped together in the methodology. For many of you, you run the risk of losing the remainder of your 5% or 25%.

EXAMPLE: Taxpayer lumps three loans together for a cumulative lump sum of $300,000. Since they are a part of a third party litigation; the taxpayer deducted $225,000 against their (2009) income

            ($300,000 x 75% = $225,000.)

This was based on the idea that the taxpayer would recover 25% of the loss ($75,000). Even if the client recovered zero dollars; they would need to wait until the closing of every loan collection effort in their lump sum. No deduction until the final resolution of all three of the loans.

There is a potential for a partial deduction; but that is really something that has to be reviewed on a taxpayer-by-taxpayer basis.

If you took the Safe Harbor Methodology for your losses: unless all of the loans you lumped together have closed out collection efforts; you have lost the ability to take the un-deducted 5% or 25% as a Section 165 Theft Loss (the collection effort will complete in a tax year after 2017). (You would still have a capital loss deduction available in the future – in many cases against 2018 capital gains.)

c) A combination of both a) and b)

From experience, I can tell you that Section 165 is so confusing that many USA Capital injured investors deducted some of the losses using the Safe Harbor Methodology for some of their loans; while not deducting other loans at all.

The loan losses not deducted using the Safe Harbor Methodology are now reviewed under the ‘legacy’ law. So any un-deducted loan losses are likely now eligible to be taken against 2014, 2015, 2016 or 2017 income; depending on the particulars of each specific loan and the recovery efforts associated with the loan.

NOTE: Non-Safe Harbor theft loss claims require no substantiating documentation to be submitted WITH THE ORIGINAL FILED RETURN. It is likely the IRS will process an original filed return and then seek the burden of proof substantiation at a future date. Do not file a claim without having your documents in order.

#4) The Section 165 Theft Loss is an Itemized Deduction (Schedule A Deduction)
The tax forms used to calculate and deduct a USA Capital Theft Loss flow to Schedule A of the taxpayers tax return. Many taxpayers do not have the items of expense to exceed the standard deduction the government already allows a taxpayer (2017 figures):

Single taxpayer = $6,350                               Married Filing Joint taxpayers = $12,700
And for those over 65 years of age:
Single = $6,350 + 1,550 = $7,900                  Married = $12,700 + $2,500 = $15,200 

So from the example above; if the taxpayer itemizes; the theft deduction is another itemized deduction increasing the total on Schedule A. 

More accurately for many USA Capital injured investors; if they are over 65 and do not itemize. The taxpayer loses the standard deduction, but gains the itemized deduction. So the $75,000 uncollected in our example removes the $15,200 standard deduction but replaces it with a $75,000 itemized deduction. But this is really a subtraction ($75,000 - $15,200 = $59,800 of actual benefit from the Section 165 deduction). If this example is more in line with your circumstances, you should keep any items available that could be an itemized deduction (mortgage interest, state and local taxes, charitable contributions, etc.) as they can be added to the Schedule A created by the Section 165 loss.

 NOTE: If the remaining amount of your uncollected losses is less that the standard deduction you are given; and you don’t itemize. There is likely no benefit in taking a theft loss; you are better served with a capital loss deduction.

#5) What is a Net Operating Loss (NOL)?
Simply put, a Net Operating Loss (NOL) is when the Section 165 deduction amount is greater than the taxpayers Adjusted Gross Income (AGI) on the tax return. When a Net Operating Loss occurs due to a Section 165 Theft Deduction, the unused amount of the deduction ‘carries’ to another tax year.

Section 165 Theft Losses ‘carry-back’ three years; meaning, if the taxpayer has a Net Operating Loss created by amending their 2016 tax return; the unused amount then carries-back to their 2013 tax return; which is amended, creating a refund from that year. Very large losses can span several tax returns. (After 2013, the loss is taken against 2014 income, then '15 and so on.)

​#5A) Can I carry a 2017 Net Operating Loss (NOL) Forward to 2018?

This is an excellent question that was e-mailed to me. If anyone has factual material that can be shared with others, please feel free to allow me to make it available.

Answer of this moment: there doesn’t seem to be anything that explicitly says you cannot.

A net operating loss created by a deduction such as USA Capital as a casualty is first a function of being an itemized deduction on Schedule A. The carry-forward of a net operating loss is a calculation that transfers to the front page of the following year’s tax return. For very large losses there is the remote prospect of a NOL carrying back three years, then forward with a deductible amount to be applied to tax year 2018 and beyond.

If you have a valid Section 165 deduction of your uncollected USA Capital investment; the question to consider is whether your future income will be similar to your past income. Most significant, considering the new tax law, is the prospect of significant near-term capital gains.Making a decision to waive your rights to carry back your net operating loss is irrevocable and a statement of that decision is filed with the tax return.

#6) Do I subtract 10% of my Adjusted Gross Income from the Deduction Amount?
No. That is tax code Section 165 (c)(3). USA Capital uses tax code Section 165 (c)(2).

#7) Recovery via a USA Capital Theft Loss
The amount of benefit (refunds) a USA Capital victim can derive is related to the amount of the theft loss and the taxpayer’s income. Two USA Capital victims can have an identical loss amount but receive different amounts of tax refund benefit.

The overall benefit can be anywhere from $0 to over 39% of the claimed loss. Generally speaking, it is probably safe to say that moving forward with a theft deduction for uncollected USA Capital losses is approximately 15% of the claim for benefit.

Example: USA Cap investor files their 2016 tax return without a theft loss. Their taxable income is $100,000. If they are married, their tax bill (without credits and other adjustments) is approximately $16,500. By amending that return with a $50,000 theft loss added; the new taxable income is $50,000 and the resulting tax bill becomes $6,576. This would generate a refund of over $9,900 (almost 20%).

The higher the income on the tax return the larger percentage of refund related to the deduction.

If you would like to request a worksheet to determine the potential of a USA Capital Theft Loss, click here.

8) What Year to Claim My Losses

Recently, information was sent regarding the status and potential for collection on several loans. Fortunately, that document was dated December of 2017 and should help pave the way for tax professionals, who have little familiarity with the technicalities of Section 165, to feel more at ease in filing a claim for benefit.

The dating of this document does not necessarily mean you HAVE to take your losses against 2017 income; and it does not definitively mean you CAN (refer again to the Safe Harbor Methodology).

If the injured USA Capital Investor's loan closed out recovery in 2016, the uncollected loss from that loan could be deductible against your 2016 income. Every loan may have a similar opportunity of tax year choices.

9) What does the IRS have to say about a USA Capital Theft Loss? 

Nothing specifically related to USA capital but click here to be taken to an IRS Web Page that discusses other frequently asked questions related to a USA Capital Theft Loss. (The link is safe, but if you'd rather copy-and-paste: https://www.irs.gov/newsroom/theft-losses-from-investments-in-ponzi-schemes-tax-treatment-of-distributions-received-from-a-trustee-receiver)

10) Be Very Careful

In 2011, TIGTA (Treasury Inspector General for Tax Administration) took a statistically valid sampling of electronically filed tax returns containing Investment Theft Loss Deductions and found that 82% of the Section 165 (c)(2) claims filed were done so erroneously. Click the link to be taken to the 2011 TIGTA report.

​Management's Response to the TIGTA report

USA Capital Injured Investors FAQ's

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This page is in the process of being updated. If you have a question, please e-mail me: smead@taxstratag.com .

Experienced Tax Law Expert