TL;DR
- Yes, some scam losses can be deductible if tied to a profit motive under IRC §165(c)(2).
- You must meet strict eligibility tests (intent to profit, qualifying transaction, direct theft loss, and documentation).
- Retirement-account losses can trigger taxes/penalties.
- Examples that qualify vs. don’t hinge on intent and transaction type.
- Next steps — document intent, act quickly, and get professional guidance before you respond or withdraw funds.
When a Scam Loss May Be Deductible
Recent law changes generally limit casualty and theft loss deductions to federally declared disasters—bad news for most personal scams. The key exception is IRC §165(c)(2), which allows a deduction for losses incurred in transactions entered into for profit. In plain English: if you were victimized while pursuing a bona fide investment or income-producing opportunity (securities, real estate, or similar), you may be able to claim a theft loss even though no disaster was declared. This path doesn’t turn back time, but it can soften the blow by recognizing the loss on your return when stringent criteria are met.
To use this exception, the profit motive can’t be vague or implied. The IRS expects evidence that you engaged in the transaction to make money—think signed agreements, wire confirmations, statements, offering materials, emails or texts, and a timeline showing that you were investing rather than gifting or lending casually. IRS guidance and case law reinforce that intent and documentation drive outcomes; investment scams may qualify, while personal or social transfers rarely do. If the loss is tied directly to the profit-seeking activity and there’s no reasonable prospect of recovery, a deduction may be on the table.
Think your loss was tied to an investment? Schedule a loss review so we can assess §165(c)(2) eligibility and timing.
Eligibility: What the IRS Looks For
To claim a profit-driven theft loss, you’ll need to satisfy several tests:
- Profit motive. Your primary intention must be economic gain. We help assemble a paper trail—communications with the promoter/scammer, subscription docs, contracts, transfer receipts, and any research you performed—to substantiate that you had a reasonable profit expectation. “I hoped to help someone” won’t qualify; “I purchased what I believed was an investment” might.
- Type of transaction. Qualifying transactions typically include traditional investment vehicles (securities, notes, partnership interests), real estate, or other income-producing activities. Personal or social transfers (gifts, loans to friends/romantic partners) generally fail the test because they lack a profit objective.
- Nature of loss. The theft or scam must stem directly from the profit-oriented transaction. Funds being diverted from your intended investment (e.g., to an overseas account) can qualify if you can show the nexus between your investment attempt and the loss, and that recovery is unlikely.
- Application of IRS guidance. IRS memoranda and rulings clarify that investment scams may be deductible when the transaction was legitimate on its face and undertaken for profit, supported by documentation and proof of payment. By contrast, transfers prompted by personal appeals (romance, emergency, or family impersonation scams) typically fall under personal casualty rules and are not deductible absent a disaster (or offset by personal casualty gains).
Put differently: the more your file looks like a bona fide investment and the less it looks like a personal transfer, the stronger your position.
Not-So-Good Tax Ramifications: Retirement Accounts
Scammers often push victims to move money fast, and that’s where retirement accounts become an expensive trap.
Traditional IRA / tax-deferred plans. If you withdraw funds to satisfy a scammer, the amount is generally taxable income for the year. If you’re under age 59½, a 10% early distribution penalty can apply, compounding the damage. Even if the funds are stolen afterward, the withdrawal itself is still taxable because it left the shelter of the retirement account. In limited situations, a 60-day rollover can mitigate the hit if you have other funds to restore the withdrawn amount on time.
Roth IRA / Roth plans. Contributions (basis) are generally tax- and penalty-free when withdrawn, subject to ordering rules and the five-year clock. But earnings withdrawn early and not for a qualifying reason can be taxable and penalized. Again, acting quickly may allow a rollover if you can redeposit other funds within 60 days.
Bottom line: before moving retirement money, get advice. Once distributed, tax and penalty consequences can be hard to unwind—even when fraud is involved.
Facing a withdrawal decision or have already moved funds? Talk to a Key 2 Accounting advisor about rollover options, penalty relief possibilities, and documentation.
Examples: What Qualifies and What Doesn’t
Example 1 — Impersonator investment scam (potentially deductible).
A “fraud specialist” convinces the taxpayer to move IRA and brokerage funds into “secure” investment accounts that are actually controlled by the scammer; money is wired overseas. The taxpayer intended to reinvest for profit, supported by transfer records and communications. Tax impact: If the taxpayer itemizes and the loss meets §165(c)(2), a theft loss may be deductible. However, traditional IRA distributions are still taxable (and possibly penalized if under 59½). If the taxpayer can replace funds within 60 days, some IRA tax/penalty may be avoided via rollover.
Example 2 — Romance scam (generally not deductible).
Funds are transferred from IRA and non-IRA accounts to “help” someone’s relative with medical bills. This reflects personal motives, not an investment. Tax impact: No casualty loss deduction. Traditional IRA withdrawals are taxable (and possibly penalized), and non-IRA sales trigger any capital gain/loss. A timely rollover may mitigate IRA consequences if other funds are available.
Example 3 — Kidnapping/voice-clone ransom scam (generally not deductible).
Under duress, the taxpayer authorizes IRA and brokerage distributions to pay a supposed ransom. The transfer is not tied to a profit-seeking transaction, so it fails §165(c)(2). Tax impact: Same as Example 2—no deduction, with normal tax/penalty rules on distributions and sales.
Why these matter: The IRS draws a clear line between profit-motivated investment losses (potentially deductible theft losses) and personal transfers (generally nondeductible). Your documented intent and the nature of the transaction decide which side you’re on.
Protect Your Assets and Move Forward
If you’ve been targeted—or already sent funds—move from panic to process:
- Preserve evidence. Save emails, texts, statements, contracts, wire confirmations, and dates.
- Assess intent and transaction type. Was this truly an investment or a personal transfer? Your records should make the profit motive unmistakable.
- Check recovery prospects. File police/FTC reports and contact your financial institution; note their responses and any case numbers.
- Model the tax impact. We’ll evaluate §165(c)(2) eligibility, itemization, timing, and retirement-account fallout (taxes, penalties, rollover windows).
- Prevent repeats. Implement verification steps for wire requests, use trusted channels only, and educate family—especially seniors—about impersonation and AI voice scams.
Contact Key 2 Accounting or upload your documents securely for a targeted review. We’ll determine deductibility, quantify tax exposure, and prepare the filings and support you need.
