In March 2025, the IRS Office of Chief Counsel issued important guidance addressing whether victims of modern financial scams may deduct their losses under Internal Revenue Code Section 165. The memorandum analyzes a range of increasingly common fraud schemes, including cryptocurrency investment scams, phishing attacks, impersonation schemes, romance fraud, and grandparent scams. For individuals who have suffered substantial losses understanding these rules is critical. The tax consequences of fraud can be significant, and careful legal analysis is often necessary to determine both deductibility and potential avenues for recovery.

MDF Law are not tax attorneys, and we do not provide tax advice. However, if you or a family member has been the victim of an online scam, including cryptocurrency fraud, our attorneys may be able to help. If you suffered financial losses, contact MDF Law at 800-767-8040 to discuss your legal options.

2005 Tax Attorney Memo from IRS

Taxpayer 1: Compromised Account Impersonation Scam

The first taxpayer was contacted by someone claiming to be a fraud specialist at a financial institution. The scammer used urgency and fear, stating that the taxpayer’s accounts had been compromised and that immediate action was required to protect the funds.

Unfortunately, these impersonation scams are increasingly sophisticated. Scammers spoof real phone numbers, send convincing emails, and use language that mirrors actual bank fraud departments. Victims are told to move funds to a “safe” account. In reality, the new account is controlled by the scammer.

In this case, the taxpayer authorized distributions from both IRA and non-IRA brokerage accounts and transferred the funds to newly created accounts. The money was immediately wired overseas and could not be recovered.

The IRS concluded that the taxpayer acted with a profit motive. The purpose of the transfer was to safeguard and continue investing the funds. Even though the taxpayer was deceived, the transaction was connected to investment activity.

Because the theft was discovered in 2024 and there was no reasonable prospect of recovery, the loss is deductible in 2024 as a theft loss incurred in a transaction entered into for profit. The deduction is limited to the taxpayer’s basis in the stolen funds. Importantly, IRA distributions triggered by the scam are still taxable, which in turn affects the basis calculation.

Taxpayer 2: Pig Butchering Cryptocurrency Investment Scam

The second taxpayer fell victim to what is commonly called a pig butchering scam. This is one of the fastest-growing forms of online investment fraud.

The scam typically begins with an unsolicited message through email, social media, or a dating platform. The scammer builds trust over time and directs the victim to a polished cryptocurrency trading website. Small initial deposits appear to generate profits. Victims are often allowed to withdraw modest amounts early on to build confidence.

Once trust is established, the victim is encouraged to invest more substantial sums. When the victim attempts to withdraw the larger amount, the account is frozen, customer support disappears, and the funds are gone.

Here, the taxpayer transferred funds from IRA and brokerage accounts to invest in what was represented as a cryptocurrency platform. The IRS had no difficulty concluding that the taxpayer acted with a profit motive. The entire purpose of the transfer was to generate income.

Accordingly, the loss qualifies as a deductible theft loss in 2024. However, the taxpayer could not use the special Ponzi scheme safe harbor because the scammer was never identified or criminally charged. That safe harbor requires an indictment or formal criminal complaint against the lead figure.

For victims of crypto fraud, this distinction is critical. Many of these scams originate overseas and never result in criminal charges, which limits safe harbor options even if the loss is otherwise deductible.

Taxpayer 3: Phishing and Account Takeover Scam

The third taxpayer was targeted in a phishing attack. The taxpayer received an email claiming the accounts had been compromised and was directed to call a listed fraud analyst. After clicking a link and entering login credentials, the scammer gained access to retirement and brokerage accounts and transferred the funds without authorization.

Unlike the first two examples, this taxpayer did not authorize any transfer. The IRS therefore analyzed the character of the stolen property itself.

Because the IRA and brokerage accounts were established for investment and retirement income purposes, the funds were clearly held with a profit motive. The theft occurred while the assets were invested.

The IRS concluded that the loss qualifies as one incurred in a transaction entered into for profit and is deductible in 2024. As in the other investment-related examples, the deduction is limited to basis.

Phishing and account takeover scams are a growing area of elder financial exploitation. Victims often face both the loss of retirement savings and unexpected tax consequences from IRA distributions triggered by the fraud.

Taxpayer 4: Romance Scam

The fourth taxpayer developed an online romantic relationship with an individual who later requested funds for a supposed medical emergency involving a relative. These romance scams frequently target older individuals and can involve months of emotional manipulation before any request for money is made.

In this case, the taxpayer withdrew funds from retirement and brokerage accounts and transferred the money overseas. The relationship then disappeared.

Although the funds were taken through fraud, the IRS concluded that the taxpayer did not act with a profit motive. The purpose of the transfer was personal — to assist someone believed to be a romantic partner — not to invest or earn income.

As a result, the loss is treated as a personal casualty loss. Under current law, most personal casualty losses are disallowed for tax years 2018 through 2025 unless connected to a federally declared disaster. Because that exception did not apply, the loss is not deductible.

The taxpayer must still recognize taxable income from IRA distributions even though the stolen funds are not deductible. This creates a particularly harsh result for victims of romance fraud.

Taxpayer 5: Grandparent or Kidnapping Scam

The fifth example involved what is often called a grandparent scam. The taxpayer received a call claiming that a grandchild had been kidnapped. The scammer used artificial intelligence to clone the grandchild’s voice, creating a believable ransom scenario.

Under intense emotional pressure, the taxpayer withdrew funds from IRA and brokerage accounts and wired them overseas. The next day, the taxpayer learned no kidnapping had occurred.

Despite the duress and deception, the IRS again focused on motive. The funds were transferred to protect a family member, not to generate income. The loss therefore constitutes a personal casualty loss and is not deductible under current law.

As with the romance scam, the taxpayer must still report IRA distributions as taxable income.

Why Motive Matters

The IRS emphasized that the origin and character of the transaction determine whether a theft loss is deductible. If the funds were transferred for investment, reinvestment, or profit-related purposes, the loss may qualify under Section 165(c)(2). If the transfer was personal in nature, even if induced by fraud or coercion, the loss is generally nondeductible through 2025.

This distinction affects victims of cryptocurrency scams, phishing attacks, impersonation schemes, romance fraud, grandparent scams, and other forms of elder financial exploitation.

The Ponzi Safe Harbor Is Narrow

Many victims assume they can use the IRS Ponzi scheme safe harbor. In reality, it applies only if the scam involves a specified fraudulent arrangement and the lead figure has been criminally charged. In modern online scams, the perpetrators are often unidentified or overseas, making the safe harbor unavailable.

What This Means for Scam Victims

Scam victims frequently face two separate financial harms: the loss of their funds and the tax consequences triggered by IRA distributions or asset sales. Determining whether a theft loss is deductible requires careful analysis of the taxpayer’s intent, the structure of the transaction, and the timing of discovery.

If you or a family member has been targeted in a cryptocurrency scam, impersonation scheme, romance fraud, phishing attack, or grandparent scam, you should speak with an attorney experienced in financial fraud and elder exploitation matters.

Frequently Asked Questions About IRS Theft Loss Deductions and Scam Victims

Can you deduct money lost in a scam on your taxes?

Sometimes. If money was stolen in connection with an investment or a transaction entered into for profit, the loss may qualify as a theft loss under Internal Revenue Code Section 165. If the funds were transferred for personal reasons, however, the loss is generally not deductible under current law through 2025.

What makes a theft loss deductible?

To be deductible, the loss must result from a criminal taking under state law. You must discover the loss during the tax year and determine that there is no reasonable prospect of recovery by the end of that year. Most importantly, the transaction must have been profit-motivated, such as an investment in securities, cryptocurrency, or a retirement account.

Are cryptocurrency scams tax deductible?

They often can be. If you transferred funds to a cryptocurrency platform or trading scheme with the intent of earning profits, the IRS may treat the loss as one incurred in a transaction entered into for profit. That can make the loss deductible, subject to limitations. The deduction is generally limited to your tax basis, not the inflated value shown on a fraudulent website.

Is a pig butchering scam deductible?

In many cases, yes. A pig butchering scam is typically structured as a fraudulent investment opportunity, often involving cryptocurrency. If the victim transferred money intending to invest and earn income, the IRS may treat the loss as deductible. Each case depends on the facts, especially the taxpayer’s motive at the time of transfer.

Are romance scam losses deductible?

Usually not. If funds were transferred to someone in a personal relationship — even if the relationship was entirely fabricated — the IRS generally treats the loss as personal in nature. Personal casualty losses are largely disallowed under current tax law through 2025 unless connected to a federally declared disaster.

What about grandparent or kidnapping scams?

These losses are typically not deductible. Even though the scam is criminal and often emotionally coercive, the money is transferred for personal reasons, not investment purposes. As a result, the IRS classifies these as nondeductible personal casualty losses under current law.

What is the difference between a profit-motivated loss and a personal loss?

A profit-motivated loss arises when funds are invested or transferred with the intent to generate income or protect an existing investment. A personal loss occurs when funds are transferred for non-investment reasons, such as helping a romantic partner or paying a ransom demand. That distinction determines whether the theft loss may be deducted.

When do you claim a scam-related theft loss?

You claim the deduction in the year you discover the loss and determine there is no reasonable prospect of recovery. You do not have to prove recovery is impossible, but you must show that, as of year-end, recovery appeared unlikely.

Can you deduct the full amount that was stolen?

Not necessarily. The deduction is generally limited to your tax basis in the stolen funds. You cannot deduct unrealized gains or fictitious profits. If an IRA distribution was triggered by the scam, that distribution may still be taxable and must be analyzed carefully.

Are IRA scam withdrawals still taxable?

In many cases, yes. If funds are distributed from a traditional IRA, the distribution is typically taxable even if the money was immediately stolen. Whether the resulting loss is deductible depends on whether the transaction was profit-motivated.

What IRS code section applies to scam-related theft losses?

Scam-related theft losses are analyzed under Internal Revenue Code Section 165. For individuals, Section 165(c) limits deductions to losses incurred in a trade or business, losses incurred in a transaction entered into for profit under Section 165(c)(2), and certain personal casualty or theft losses under Section 165(c)(3). Whether a scam loss is deductible depends largely on which category applies.

What is a theft loss under IRS Section 165?

Under Section 165, a theft loss includes any criminal appropriation of property under applicable state law. This can include fraud, larceny, embezzlement, and other forms of financial deception. The loss must be discovered during the tax year, and there must be no reasonable prospect of recovery at year-end.

Are cryptocurrency scam losses deductible under IRS Section 165?

They may be. If funds were transferred to a cryptocurrency platform or digital asset investment with the intent to earn profits, the loss may qualify under Section 165(c)(2) as a transaction entered into for profit. The deduction is generally limited to the taxpayer’s basis in the stolen funds, not the value shown on a fraudulent trading platform.

Can you use the IRS Ponzi safe harbor for crypto scams?

Most victims cannot. The Ponzi safe harbor requires that the lead figure of the scheme be criminally charged by indictment or formal complaint. Many modern cryptocurrency and online scams involve unidentified or overseas actors who are never formally charged, making the safe harbor unavailable.

Should you speak with an elder fraud attorney or crypto recovery attorney?

Absolutely. Scam losses frequently involve retirement accounts, brokerage platforms, or digital assets. An experienced elder fraud attorney or crypto recovery attorney can evaluate whether the loss may qualify as a deductible theft loss and whether civil recovery options exist against financial institutions, exchanges, or third parties.

What should you do if you were scammed from a retirement or crypto account?

Immediately notify the financial institution and file a police report. Preserve all communications and transaction records. Then consult legal counsel. The timing of discovery, the structure of the transaction, and how the funds were moved can all affect both tax treatment and recovery strategy.

If you or a family member has suffered losses from cryptocurrency fraud, impersonation scams, phishing attacks, romance fraud, or grandparent scams, contact MDF Law at 800-767-8040. Early legal intervention can make a meaningful difference in both financial recovery and tax consequences.

Want to Speak with an Attorney?

MDF Law represents victims of financial fraud nationwide. If you have suffered losses involving retirement accounts, brokerage platforms, or cryptocurrency investments, contact our office at 800-767-8040 to discuss your options.

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