The Expert Podcast

So, as a victim of a Ponzi scheme, a scam, or some kind of online fraud, in addition to trying to recover assets from that scam, one of the other questions that comes up is: Can I deduct those losses off my taxes? This is a very common question.

Look, if you put money in and you show a big profit, you would have to pay tax on that. However, if it turns out to be a scam, those profits are really an illusion, and that might affect your taxes. Now, remember, we're not tax attorneys or tax accountants—we're not giving you legal or accounting advice. We're just sharing what we've seen in the operations of fraud recovery and fraud investigations.

The IRS has a very specific procedure for how to determine losses from fraud. Here’s a printout from their bulletin—it’s actually 165 losses in the 26 Code Section. If it's a loss from criminal fraud or embezzlement, that’s subject to personal loss limits or the limits of itemized deductions. You have to go through a process of determining what year the loss happened and, more importantly, whether this scam or Ponzi scheme has already been established as a loss.

Remember, in the Bernie Madoff case in 2008, the IRS didn’t come out with rules about this until 2009. So, for many victims of fraud or scams, you may have to wait until the perpetrator is charged, arrested, or the scam itself is officially determined to be a fraud. In the meantime, it may still be considered a profitable ongoing enterprise.

One reason this issue comes up is the FTX cryptocurrency fraud case. Your financial statements showing a profit might be a determining factor in your taxes, even if you can’t actually access that money. For example, if you put in $10,000 and your account balance went up to $100,000, you might have a $90,000 paper profit—which you’d have to pay taxes on. If the perpetrator of the alleged fraud isn’t arrested or officially charged for a while, you may not be able to claim that loss until that happens.

So, use these rules—CFR 26 CFR—as a guideline with your tax accountant to determine whether you can deduct these losses. In some fraud cases, you may even need to file a tax extension until the fraud is actually prosecuted.

In the meantime, continue your asset recovery process to try to get your money back. But at the same time, consider the tax implications of your paper profit and your eventual fraud loss.