The short version
A theft or fraud loss file needs more than a police report and a dollar total. Before you file or amend, the file should show what property was stolen, that the loss fits a tax-recognized theft theory, when you discovered the loss, whether reimbursement was reasonably possible, and how the deduction amount was measured.
The IRS proof framework in Publication 547 is practical: prove the theft, prove ownership, prove discovery timing, and prove the reimbursement picture. For financial scams, the file also needs to support the profit-motive path under IRC 165(c)(2), because many personal scam losses do not become deductible just because the facts are sympathetic.
What the law actually requires
IRC 165 allows a deduction for a loss sustained during the tax year and not compensated by insurance or otherwise. For individuals, the statute narrows the deduction to trade or business losses, losses from a transaction entered into for profit, and certain casualty or theft losses.
That distinction drives the document request. A tax file for a theft or fraud loss should not merely show that money left your account. It should show which IRC 165 category you are relying on, whether the property was personal-use, business, or income-producing, and how the facts support the return position.
IRS Topic no. 515 states that personal casualty losses are losses not connected to a trade or business or profit-motivated transaction, and it explains that insured losses require a timely reimbursement claim and a reduction for reimbursement or expected reimbursement. Topic 515 also points taxpayers to Form 4684, which is attached to the return to report casualty and theft gains and losses.
Adjusted basis is the tax starting point for measuring many loss claims. In plain English, it usually begins with what you paid or invested in the property, then changes for tax adjustments such as improvements, depreciation, amortization, or depletion, depending on the property and account involved.
The IRS proof file, translated into a checklist
Publication 547 says a theft loss file should support four basic points: ownership, that the property was stolen, when the missing property was discovered, and whether a reimbursement claim exists with a reasonable expectation of recovery.
For a fraud-loss file, that turns into five document buckets:
| File bucket | What to gather | What it proves |
|---|---|---|
| Ownership and basis | Bank statements, brokerage statements, wallet records, exchange records, purchase confirmations, Form 1099 records, receipts, contracts, loan documents, or prior tax workpapers. | You owned the property and can support adjusted basis or account-level tax consequences. |
| Theft or fraud facts | Police report, FBI IC3 report, state attorney general complaint, platform complaint, exchange support ticket, bank fraud report, correspondence, screenshots, or a written chronology. | The loss was theft or fraud under the relevant facts, not a simple market decline or lost property. |
| Timing | Date-by-date timeline, discovery date, account lockout notices, failed withdrawal records, bounced communications, law enforcement filings, and bank or exchange responses. | The tax year in which the loss was discovered and whether the claimed year is supportable. |
| Recovery prospects | Insurance claim, bank recall request, chargeback, exchange recovery ticket, receiver or bankruptcy notice, legal demand, denial letter, closure email, or other recovery-status evidence. | Whether reimbursement or recovery was reasonably expected when the deduction is claimed. |
| Return mechanics | Draft Form 4684, prior return, amended return draft, Schedule A or business schedule support, Form 8949 support, retirement-account forms, and explanation statement. | How the claim is reported and whether related tax consequences have been handled. |
The checklist should be assembled before the return position is chosen. If the evidence cannot answer these questions, the file may not be ready for filing or amendment.
The numbers the file has to support
The IRS guidance is not just a narrative standard. It requires concrete numbers and line choices.
| Item to support | Number or filing point | Primary source |
|---|---|---|
| Individual loss category | IRC 165(c) lists 3 individual loss categories: trade or business, profit-motivated transaction, and certain casualty or theft losses. | IRC 165 |
| Theft proof questions | Publication 547 identifies 4 core theft proof points: ownership, stolen property, discovery timing, and reimbursement claim status. | Publication 547 |
| Loss amount computation | Publication 547 starts with adjusted basis and fair market value change, then subtracts insurance or other reimbursement received or expected. | Publication 547 |
| Return attachment | Form 4684 is attached to the return to report casualty and theft gains and losses. | About Form 4684 |
| Fraudulent investment arrangement path | Form 4684 instructions require identifying information for the individual or entity that conducted the fraudulent arrangement when Section C is not used. | Instructions for Form 4684 |
| Ponzi-type Section C path | Section C is limited to taxpayers who qualify for and choose the Revenue Procedure 2009-20 procedures, as modified. | Instructions for Form 4684 |
If a file has a large claimed loss but weak support for basis, ownership, recovery efforts, or the correct Form 4684 path, the number is exposed.
What belongs in the timeline
Build the timeline in a simple sequence:
- When the first contact, pitch, platform access, or transaction occurred.
- When each transfer, withdrawal, wallet movement, asset sale, or account distribution occurred.
- When the taxpayer first discovered the property was missing or unrecoverable.
- When reports, claims, bank recalls, exchange tickets, insurance claims, or legal demands were filed.
- When those channels denied, closed, stalled, or otherwise showed that recovery was no longer reasonably expected.
The timeline matters because IRC 165 treats theft losses as sustained in the year the taxpayer discovers the loss, but Publication 547 also requires attention to reimbursement claims with a reasonable expectation of recovery. A deduction file should explain both the discovery date and the recovery-status date, especially if the taxpayer is amending a prior year.
Common documentation gaps
The first gap is a missing basis trail. A bank wire proves money left an account, but it may not prove adjusted basis, account tax treatment, crypto cost basis, retirement-account consequences, or whether taxable income was created before the theft-loss question begins.
The second gap is a weak profit-motive file. For an IRC 165(c)(2) position, keep the investment pitch, platform screenshots, account statements, promised returns, trading records, withdrawal history, and communications that show why the transaction was entered into for profit. A personal emergency payment or relationship-based transfer usually needs a different expectation discussion.
The third gap is an incomplete recovery file. A taxpayer may have contacted a bank, exchange, insurer, police department, or platform support team, but the tax file should preserve the actual dates, ticket numbers, submissions, responses, denials, and closure records.
The fourth gap is assuming every fraud loss belongs in the Ponzi-type section of Form 4684. The Form 4684 instructions separate general fraudulent investment arrangement reporting from the special Section C path for taxpayers who qualify for and choose the Revenue Procedure 2009-20 procedures.
Before you file or amend
Use the checklist as a readiness test:
- Can you prove ownership and adjusted basis without relying only on memory?
- Can you show why the loss is theft or fraud, not a market decline, lost property, or a personal transfer with no profit motive?
- Can you identify the discovery year and the status of every realistic recovery channel?
- Can you explain the Form 4684 reporting path before the return is signed?
- Can you preserve the source documents in a way that would make sense to someone reviewing the file months later?
If the answer to any of those questions is no, the next step is document cleanup, not filing first and hoping to explain it later.
Related reading
This IRC 165 series should eventually connect this checklist to the planned ST pillar on IRC 165(c)(2), the planned profit-motive article, and the planned timing article on reasonable prospect of recovery. Those sibling articles are not linked in this draft because they are not yet owner-approved live pages.
If you already filed the claim and received a notice or audit letter, the issue may move from ST planning to an STR response path. That STR article is also not linked here until it is live and owner-approved.
How Sheepdog Tax can help
Sheepdog Tax can review the loss file before you file or amend, identify missing proof, and organize the records around ownership, basis, theft facts, discovery timing, recovery prospects, and Form 4684 reporting. The goal is to make the return position easier to understand before it is submitted and easier to defend if questioned later.
Download the loss-documentation checklist or request a file review before you commit to a return position.
Sources (primary authority first)
- 26 U.S.C. 165, Losses.
- IRS Publication 547 (2025), Casualties, Disasters, and Thefts.
- IRS Topic no. 515, Casualty, disaster, and theft losses.
- IRS About Form 4684, Casualties and Thefts.
- IRS Instructions for Form 4684 (2025), Casualties and Thefts.
Prepared by Noah Green, CPA, CFE.