Falling victim to a scam is painful enough. The tax consequences can feel like a second hit—especially now that the tax law generally limits casualty and theft-loss deductions to losses connected to federally declared disasters.
However, there is still a meaningful path to potential tax relief for certain scam victims. The key is whether your loss arose from a profit-motivated transaction rather than a purely personal event.
Below is a practical, reader-friendly guide to the strategy, the rules that govern it, and the documentation you will need if you want the IRS to take your position seriously.
Why Scam Loss Deductions Became Harder (and Where the Exception Lives)
Historically, many unreimbursed theft losses could be deducted. Legislative changes narrowed this significantly, largely restricting deductions to disaster-associated events. That change leads many scam victims to assume: “There’s no deduction available.”
Not always.
If you participated in the transaction under circumstances showing a credible expectation of profit, a deduction may still be available under Internal Revenue Code Section 165(c)(2). This provision addresses losses from activities entered into for profit, even when the loss results from theft or fraud—without requiring a federally declared disaster.
This is especially relevant for scams that resemble investments: fake securities, fraudulent real estate deals, “guaranteed return” programs, and other income-producing ventures.
The Core Strategy: IRC Section 165(c)(2) and Profit-Motivated Losses
IRC §165(c)(2) allows individuals to deduct losses incurred in transactions “entered into for profit.” In practical terms, it creates a potential deduction lane for scam victims when:
- The transaction was structured like an investment or income-producing activity, and
- The loss is directly tied to that profit-seeking activity, and
- You can prove your intent and the facts with strong documentation.
This is not a casual deduction. It is a high-scrutiny area where your facts and records do the heavy lifting.
Qualification Checklist: What the IRS Will Look For
To claim a scam-related loss under the profit-motive rules, you generally must satisfy all of the following:
1. Clear Profit Intent (Not Just “I Hoped It Would Work”)
The IRS expects convincing evidence that your primary purpose was economic gain. Your documentation should demonstrate a sincere, businesslike profit expectation—consistent with IRS guidance, case law, and IRS determinations.
Strong indicators include:
- Investment proposals and marketing materials describing returns
- Written communications discussing profit, yield, appreciation, or income
- Proof of due diligence efforts (even if imperfect)
- Transaction timelines showing investment-like behavior (subscriptions, “statements,” confirmations)
2. The Right Transaction Category
The transactions that typically fit this exception are those that look like:
- Securities or investment accounts
- Real estate investments
- Income-producing ventures
- Other activities where profit is the central objective
By contrast, losses tied to personal relationships, gifts, or social interactions generally fall outside this scope—no matter how large the loss.
3. Direct Link Between the Scam and the Profit-Seeking Activity
There must be a clear connection between:
- The funds you paid or transferred, and
- The profit-oriented transaction you believed you were entering, and
- The fraudulent conduct that caused the loss
This is where records matter most: wiring instructions, “investment account” screenshots, correspondence, contracts, payment receipts, and any evidence that the arrangement was presented as an investment.
IRS Guidance Matters: Why Memoranda and Rulings Are Important
In evaluating whether a scam loss qualifies, taxpayers and advisors often look to IRS guidance for how the Service analyzes profit-driven scam losses. For example, IRS Chief Counsel Memorandum (CCM 202511015) provides clarification around when losses may qualify, emphasizing themes such as:
- Investment fraud can qualify when the facts support a credible profit motive
- Losses are evaluated closely, and documentation is critical
- The IRS distinguishes profit-motivated transactions from personal, informal, or relationship-based exchanges
The takeaway: if the story looks like “an investment went wrong due to fraud,” you may have a pathway. If it looks like “money was sent because of a personal relationship,” the deduction argument collapses.
Retirement Accounts and Scams: The Tax Trap Many Victims Don’t Expect
Even sophisticated taxpayers can be pressured into moving retirement funds quickly. When an IRA or retirement plan is involved, scam losses can create tax consequences that are both immediate and expensive.
Traditional IRAs and Deferred Retirement Plans
If funds are withdrawn—even due to fraud or deception—the withdrawal can still be treated as taxable income. That means:
- The distribution may increase taxable income and potentially push you into a higher bracket
- If you are under age 59½, a 10% early withdrawal penalty may apply
- The tax cost can arise even though you did not benefit from the withdrawal
In certain situations, remediation within 60 days may matter (for example, where rollovers are involved), but the rules are technical and fact-specific.
Roth Accounts
Roth accounts are generally treated less harshly because contributions are made with after-tax dollars. However:
- Withdrawn earnings (not contributions) may be taxable and penalized if the distribution is not qualified
- The details depend on account history, age, and the nature of the withdrawal
If a scam involved retirement funds, do not assume “the scam cancels the tax.” In many cases, it does not.
Two Examples That Clarify What Qualifies (and What Doesn’t)
Example 1: “Fraud Specialist” / Protective Transfer With Intent to Reinvest — Potentially Deductible
A taxpayer is persuaded to move funds to a “secure” channel with the understanding that the assets will be protected and then reinvested for profit. Although the victim’s immediate motivation includes protection, the broader transaction reflects an intent to preserve capital for reinvestment and profit.
Why it can qualify: The surrounding facts indicate a profit-oriented purpose and an investment-like transaction, allowing the loss to be analyzed as a theft loss tied to a profit motive.
Potential tax effects (depending on the full facts):
- If itemizing, the loss may be reported as a deduction on Schedule A
- Traditional IRA distributions can still be taxable
- Early withdrawal penalties may apply if under 59½, unless the situation meets a specific exception or timely corrective steps apply
Example 2: Romance Scam — Not Deductible
A taxpayer sends money based on emotional manipulation and personal connection. There is no investment structure, no profit expectation, and no income-producing transaction—only a personal relationship context.
Why it does not qualify: Without a profit motive, the loss generally cannot be deducted under the profit-oriented exception. Personal and relationship-driven transfers are typically non-deductible.
Tax effects: If retirement funds were used, the taxable distribution issue can still arise even though the loss itself is not deductible.
The Real Make-or-Break Factor: Documentation
When claiming a non-disaster scam loss tied to profit intent, the IRS will expect rigorous evidence. Treat documentation as your defensive file.
Focus on:
- Proof of payments: bank records, wires, checks, crypto transfers
- Communications: emails, texts, chat logs, “adviser” messages, platform messages
- “Investment” materials: statements, portals, dashboards, promised returns
- Notes on intent: why you believed it was profit-driven, what representations were made
- Reports: police report, FTC report, bank fraud report, platform complaints (as applicable)
If you cannot document the profit story, you should assume the IRS will not accept it.
Practical Next Steps: Protect Yourself and Your Family
- Stop the bleed early. If you suspect fraud, pause transactions and contact your financial institution immediately.
- Preserve evidence. Don’t delete messages or close accounts before capturing records.
- Get professional guidance quickly. Timing, account types, and reporting options can materially change the outcome.
- Educate vulnerable family members—especially elders. Many scams target seniors with urgency, fear, and authority cues.
If you suspect fraudulent communication, contact our office promptly. We can help you assess the situation, identify red flags, and determine whether any deduction strategy may apply based on your specific facts and documentation.