The short version
A theft or scam loss is not deductible just because the money is gone from your account. Under IRC 165, timing depends on when the loss is sustained, and the reasonable prospect of recovery rule can delay that year.
For theft losses, IRC 165(e) starts with the year you discover the loss. Treasury regulations add the next question: if a claim for reimbursement still has a reasonable prospect of recovery, the deductible loss is not sustained until the recovery question can be answered with reasonable certainty.
That is why filing or amending too early can be risky. The tax file should show not only what was stolen, but also what recovery channels existed, what happened to those channels, and when the remaining recovery path stopped being realistic.
What the law actually says
IRC 165 allows a deduction for a loss sustained during the tax year and not compensated by insurance or otherwise. For individuals, the statute limits deductible losses to trade or business losses, transactions entered into for profit, and certain casualty or theft losses.
For theft losses, IRC 165(e) says the loss is treated as sustained in the tax year in which the taxpayer discovers the loss. That discovery-year rule is not the end of the analysis.
Treas. Reg. 1.165-1(d)(2)(i) provides that when a casualty or other event may result in a loss and a claim for reimbursement has a reasonable prospect of recovery, the covered part of the loss is not sustained until it can be determined with reasonable certainty whether reimbursement will be received. The regulation also says the existence of a reasonable prospect is a question of fact based on all facts and circumstances.
Treas. Reg. 1.165-1(d)(3) applies that same concept to theft losses. A theft loss is generally treated as sustained in the discovery year, but if a reimbursement claim with a reasonable prospect of recovery exists in that year, the reimbursable portion waits until the tax year when recovery can be determined with reasonable certainty.
Treas. Reg. 1.165-8 reinforces the same point for theft losses and gives an insurance-dispute example. The example delays the theft-loss deduction until the later year when the insurance controversy is settled.
What “reasonable prospect of recovery” means in practice
The test is not whether you hope to recover the money. It is also not whether recovery is impossible in an absolute sense. The issue is whether, at the end of the tax year you want to claim, the facts still show a meaningful reimbursement or recovery path.
For a scam or theft file, recovery prospects may include:
| Recovery channel | What the tax file should show | Why it matters |
|---|---|---|
| Bank recall, wire recall, chargeback, or exchange ticket | Request date, response, denial, partial recovery, or closure. | Shows whether the financial institution route was still open. |
| Insurance claim | Policy terms, claim filing, adjuster correspondence, denial, settlement, or release. | Insurance is the classic reimbursement claim in the regulations. |
| Civil claim, arbitration, receivership, bankruptcy, or restitution process | Demand letters, pleadings, docket status, receiver notices, distribution estimates, settlement, judgment, or abandonment. | A real third-party claim can delay the sustained-loss year for the covered portion. |
| Law-enforcement report or agency complaint | Report date, assigned case number if available, and any recovery communication. | Supports theft documentation but usually does not, by itself, prove the tax year. |
| No practical recovery path | Written denials, closed support tickets, insolvent wrongdoer evidence, abandoned claim evidence, or records showing no identifiable recovery source. | Supports reasonable certainty that reimbursement will not be received. |
The key is objective evidence. Under the regulation, reasonable certainty can come from a settlement, an adjudication, or abandonment of the reimbursement claim. If the taxpayer says the year was fixed by abandoning the claim, the regulation expects objective evidence of abandonment, such as a release.
How the timing can change the deduction year
Assume a taxpayer discovers in November 2025 that 90,000 dollars was stolen in an investment-style online scam. The taxpayer immediately files a bank recall request, an exchange support ticket, and a claim under an insurance policy that may cover cyber theft.
If the bank and exchange both deny recovery before year-end, but the insurance claim remains open with a realistic chance of payment, the covered portion of the loss may not be sustained in 2025. The tax answer may wait until the insurance claim is settled, denied, adjudicated, or objectively abandoned.
Now change the facts. The bank recall fails in 2025, the exchange confirms it cannot reverse the transfer, there is no insurance coverage, no receiver, no bankruptcy estate, no identifiable solvent wrongdoer, and no other reimbursement claim. The discovery year and the sustained-loss year may line up, assuming the rest of the IRC 165 requirements are met.
The dollar amount does not decide the test. A large loss can still have a recovery prospect. A small loss can be final quickly. Timing turns on the recovery facts, not how badly the taxpayer needs the deduction.
The numbers
The timing rule is easier to see as a decision table:
| Fact pattern | Potential tax year result | Source |
|---|---|---|
| Theft loss discovered in Year 1 and no reimbursement claim with a reasonable prospect exists. | Theft loss is generally treated as sustained in the discovery year, if other IRC 165 requirements are met. | IRC 165(e); Treas. Reg. 1.165-1(d)(3) |
| Theft loss discovered in Year 1, but a reimbursement claim with a reasonable prospect exists for the full loss. | The reimbursable portion is not sustained until the year recovery can be determined with reasonable certainty. | Treas. Reg. 1.165-1(d)(2)(i) and (d)(3) |
| Only part of the loss is covered by a claim with a reasonable prospect of recovery. | The uncovered portion may be sustained earlier; the covered portion waits. | Treas. Reg. 1.165-1(d)(2)(ii) |
| A taxpayer deducts a loss and later receives reimbursement. | The taxpayer generally does not recompute the earlier year, but includes the reimbursement in income subject to the tax-benefit rule. | Treas. Reg. 1.165-1(d)(2)(iii) |
| Financial scam victim claims a theft loss under current IRS instructions. | The IRS identifies three conditions: theft under state law, no reasonable prospect of recovering the stolen funds, and a transaction entered into for profit. | Instructions for Form 4684 |
This table is not a substitute for return advice. It is a way to separate the timing question from the separate questions of theft classification, profit motive, adjusted basis, and reporting mechanics.
What this means before filing or amending
Before you claim the loss, build the timeline. The timeline should identify the date of discovery, the tax year you want to claim, every recovery channel that existed, and the date each channel was denied, settled, closed, abandoned, or otherwise became no longer realistic.
For a scam loss, also keep the reasonable-prospect analysis separate from the profit-motive analysis. Publication 547 and the Instructions for Form 4684 discuss financial scam losses, but they do not turn every scam into a deductible loss. The taxpayer still needs theft treatment under applicable state law, no reasonable prospect of recovering the funds, and a transaction entered into for profit.
If you already filed and later realized the timing may be wrong, do not amend reflexively. The amendment should be tied to the source documents that show the correct sustained-loss year. If the timing evidence is weak, an amended return can create the same audit issue you were trying to fix.
Common timing mistakes
The first mistake is treating the police report date as the deduction year. A police report can help document the theft, but it does not answer whether there was a reimbursement claim with a reasonable prospect of recovery.
The second mistake is treating a pending claim as irrelevant because recovery feels unlikely. The regulation asks for facts and circumstances. Open insurance claims, bank recalls, receiverships, litigation, bankruptcy distributions, and restitution proceedings can matter, even if the taxpayer is skeptical.
The third mistake is waiting too long after the file has become objectively final. When all meaningful recovery paths have closed, the sustained-loss year may already have arrived. Waiting because the taxpayer is still emotionally processing the loss is different from waiting because a real reimbursement claim remains open.
The fourth mistake is claiming the whole loss in one year when only part of the loss is unresolved. The regulation can split the analysis between the portion covered by a recovery claim and the portion not covered.
Related reading
This article should eventually sit between the planned IRC 165(c)(2) pillar and the planned article on amending a return for a theft or scam loss. Those related articles are not linked here until the owner approves live URLs.
If you have already claimed the loss and received an IRS notice, the issue moves from planning into response. The planned IRS notice-response article should be linked only after it is live and owner-approved.
How Sheepdog Tax can help
Sheepdog Tax can review the loss timeline before you file or amend, test the recovery-prospect evidence against the current IRC 165 rules, and help organize the documents into a defensible Form 4684 position. The review focuses on timing, recovery evidence, profit motive, theft classification, basis, and the return position the file would need if questioned later.
Consult with us before claiming or amending to ensure proper timing.
Sources (primary authority first)
- 26 U.S.C. 165, Losses.
- 26 CFR 1.165-1, Losses.
- 26 CFR 1.165-8, Theft losses.
- IRS Publication 547 (2025), Casualties, Disasters, and Thefts.
- IRS Instructions for Form 4684 (2025), Casualties and Thefts.
Prepared by Noah Green, CPA, CFE.