When investments go bad, the IRS offers one consolation - you probably can claim a loss on your income tax return.
In most situations, that means a capital loss that gets deducted at the painfully slow rate of $3,000 a year. It's faster only if you have capital gains that can be used to offset it. In that scenario, if you lost $100,000, it would take more than 30 years to write it all off. But if you can prove you were the victim of a documented fraud, you may be eligible to deduct your loss under far more generous terms.
"We can't make them whole, but for many people, for us to able to assist them in getting back even $10,000 is huge," said Moira Souza-Shiver, vice president of JK Harris 165 Services of Tampa.
The company's specialty is helping investors and their tax preparers document that investment losses were theft - not just bad investments - in a fashion that will pass muster with the IRS.
"It has to be a proven fraud and you need to be able to prove to the IRS that you have exhausted all legal means trying to recover the money," Souza-Shiver said. If you pass the test, the loss is fully deductible. When losses exceed taxable income, they can be spread over multiple years, backward and forward, said Alan Gavel, tax lawyer at 165 Services, which takes its name from Section 165 of the IRS code. The backward part works by filing amended returns for the previous three years.
Not that it's easy. JK Harris 165 Services is in this business because claiming investment theft losses is no slam dunk. Many tax preparers aren't even familiar with the process.
"I inform the client that we can expect to be audited and to feel fortunate if we're not," Gavel said. The IRS audits about half of his cases, but he said investors usually prevail and JK Harris refunds its fees if they don't. The company's fee, including audit representation, is 4 percent of the net deductible loss, with a $2,000 minimum. He said getting a refund takes about 10 months, although some cases take a few weeks and others take years.
So how do you document fraud? In some cases, regulators file fraud charges. In other cases, investors prove it by filing a lawsuit or arbitration case based on a claim of fraud or theft. If you win the legal action but collect less than your loss, you may be able to get a deduction for the difference. However, Gavel says it's more difficult to qualify if a case is settled without an admission of fault.
Ordinary capital losses (the $3,000-a-year kind) are taken in the year an investment is sold or becomes worthless. An investment theft deduction is taken the year you've exhausted all means of recovery.
When a receiver has been appointed, as often happens in bankruptcy and fraud cases, Souza-Shiver said, the IRS requires investors to wait until the receiver states how much will be recovered. That may mean waiting a year or longer.
If the money was in a retirement account or your income is so low that you don't pay taxes, you're out of luck. The deduction for an investment loss of any kind is limited to the tax basis in the investment. Your tax basis in an IRA or other retirement plan is zero unless you made nondeductible contributions. Even then you can't take the loss until you've withdrawn all the money from your IRAs.
Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, write firstname.lastname@example.org or Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731. Read more questions and answers at http://blogs.tampabay.com/money