The FBI logged more than $9 billion in reported losses from investment fraud and business email compromise in a single recent year, and the real number is higher because shame keeps many victims from ever filing a report. The cruelest variety has an ugly nickname: pig butchering. The scammer spends weeks or months building trust, often through a dating app or social media, then walks the victim into a fake trading platform showing spectacular gains, and disappears the day a real withdrawal is requested. The money is usually gone for good. What is left, for some victims, is a meaningful tax deduction under I.R.C. § 165, and whether you can claim it turns almost entirely on one question: what did you think you were doing when you sent the money?
Why does the tax code treat scam victims differently from disaster victims?
Section 165 allows individuals three categories of loss deduction: losses in a trade or business under § 165(c)(1), losses in transactions entered into for profit under § 165(c)(2), and personal casualty and theft losses under § 165(c)(3). The 2017 tax law suspended the third category for all but federally declared disasters, and the 2025 tax legislation carried that limitation forward. That change gutted the deduction for purely personal thefts. But it never touched § 165(c)(2). A loss on a transaction entered into for profit remains fully deductible as an itemized deduction, with no disaster declaration required, no $100 floor, and no 10 percent of adjusted gross income haircut.
That is the entire ballgame for pig butchering victims. These scams are, by design, fake investments. The victim believed they were funding a brokerage account, a crypto position, or a gold trade. That profit motive is what moves the loss from the suspended personal category into the still-alive investment category. The IRS Office of Chief Counsel reached exactly this conclusion in a 2025 memorandum analyzing a series of scam fact patterns: where the victim transferred funds expecting an investment return, the theft loss stayed deductible; where the victim sent money for reasons of the heart, with no profit expectation, the deduction was gone.
What counts as “theft” for a New Mexico victim?
Theft for § 165 purposes is measured by state law. New Mexico’s fraud statute, NMSA 1978, § 30-16-6, makes it a crime to take anything of value by fraudulent conduct, practices, or representations, and larceny and embezzlement statutes fill in the edges. A pig butchering scheme, inducing transfers through fabricated identities, fabricated platforms, and fabricated returns, sits comfortably inside those definitions. You do not need a conviction. You do not even need the scammer’s real name. What you need is evidence that a criminal taking occurred under the law of the state where you were fleeced, and that you were not simply a disappointed investor in a legitimate venture that went bad.
When do you claim the loss, and why is timing a trap?
Section 165(e) fixes the deduction in the year the theft is discovered, not the year the money left your account. Discovery sounds simple, but there is a second gate: under Treas. Reg. § 1.165-1(d), no deduction is allowed for any portion of the loss with a reasonable prospect of recovery. If your civil suit against a money mule is pending, or an exchange has frozen some of the funds, or law enforcement has seized a wallet with traceable assets, the deductible amount is reduced until those prospects resolve. Claim too early and the IRS disallows the premature portion; wait too long and you may strand the deduction in a closed year. In practice the analysis runs claim by claim: the portion with no realistic recovery path is deductible now, and the remainder rides until the recovery effort dies.
How much is the deduction actually worth?
Consider a retired Albuquerque couple who moved $120,000 from an IRA and savings into what they believed was a crypto trading platform, watched a dashboard show it grow to $310,000, and lost every dollar when the platform vanished. Two numbers matter. The deductible theft loss is the $120,000 actually stolen, the tax basis of what they parted with, never the $190,000 of phantom gains the dashboard displayed. And if any part of the stolen funds came out of a traditional IRA, there is a second wound: the withdrawal itself was taxable income when it came out, even though a scammer ended up with the cash. The § 165(c)(2) deduction, taken as an itemized deduction on Schedule A via Form 4684, is what offsets that income. For this couple, the deduction could erase most of the federal tax on the year of the theft, and because New Mexico’s personal income tax starts from federal taxable income, the benefit flows through to the state return automatically. On combined federal and New Mexico rates in the mid-30s, documentation is worth real money: roughly $40,000 in tax on these facts.
| Scenario | Profit motive? | Deductible after TCJA? |
|---|---|---|
| Fake crypto or brokerage platform (classic pig butchering) | Yes | Yes, § 165(c)(2) |
| Ponzi scheme with charged promoter | Yes | Yes, and the Rev. Proc. 2009-20 safe harbor may simplify proof |
| Romance scam, money sent as gifts or “emergencies” | No | Generally no, § 165(c)(3) suspended |
| Kidnapping or blackmail payment | No | Generally no |
| Business account drained by email compromise | Business loss | Yes, § 165(c)(1) |
What documentation makes or breaks the claim?
The IRS treats large theft loss deductions as audit bait, so the file has to be built like an exhibit binder. That means the complete message history with the scammer, screenshots of the fake platform and its fabricated balances, wire and crypto transaction records tracing every dollar out, the police report, the FBI IC3 complaint, any report to the New Mexico Department of Justice’s consumer protection division, and a written chronology of the recovery efforts that failed. A Form 8275 disclosure statement is often prudent for a sizable claim. This is precisely the kind of substantiation an attorney-CPA builds for a living, and it doubles as the record you will want if any recovery litigation ever does bear fruit.
Could Congress make this easier for fraud victims?
Possibly. The House Ways and Means Committee advanced the Tax Relief for Fraud Victims Act, H.R. 9500, with unanimous bipartisan support in July 2026. The bill would expand the deduction for losses arising from fraud, deceit, or misrepresentation, softening the TCJA’s suspension for victims who currently fall on the wrong side of the profit-motive line. It is not law, and Senate action is uncertain, but the direction of travel is clear: Congress knows the current rule punishes romance scam victims twice. Until something passes, the profit-motive analysis under existing § 165(c)(2) is the road that exists.
Frequently Asked Questions
I withdrew from my IRA to fund the “investment.” Do I still owe tax on the withdrawal?
Yes, the distribution is taxable income in the year taken, and if you were under 59 and a half, the 10 percent early withdrawal penalty can apply too. The theft loss deduction is the counterweight, which is why claiming it correctly matters so much for retirement account victims.
The scammer showed my account growing to triple what I put in. Can I deduct what it was “worth”?
No. The deduction is limited to your basis, the actual dollars you parted with. Phantom gains on a fabricated dashboard were never income to you and are never deductible as a loss.
Do I need the scammer to be caught or charged?
No. You need to show a theft occurred under state law and that your recovery prospects are exhausted or quantifiable. Prosecution helps the proof, and it unlocks the Ponzi-scheme safe harbor when a lead figure is charged, but it is not a legal prerequisite.
I never itemize. Does the deduction still help me?
A § 165(c)(2) theft loss is an itemized deduction, so it only helps if your total itemized deductions exceed the standard deduction. For losses of this size they almost always do, and in a big-loss year, itemizing becomes the obvious play.
Can I amend a prior year if I discovered the theft two years ago?
If the discovery year’s return omitted the deduction, an amended return within the refund statute, generally three years from filing, can recover the overpayment. The discovery-year rule controls which year gets amended, and that analysis is worth doing carefully before any statute closes.
How North Star Law Firm Can Help
North Star Law Firm represents New Mexico fraud victims in documenting and claiming theft loss deductions, defending those claims on examination, and coordinating the tax position with recovery litigation. Phillip Zagotti, JD/CPA, represents taxpayers before the IRS under Circular 230, and the CPA half of the practice builds the substantiation file the deduction lives or dies on. The firm’s tax defense practice handles the audit defense that a six-figure deduction can attract, and if the loss left you unable to pay other tax balances, the firm evaluates every collection alternative from offers in compromise to installment agreements. If a scam took your savings, contact North Star Law Firm before you file the next return; the discovery-year clock is already running.