Theft Losses Summary
IRC § 165(a) provides as a general rule that “any loss sustained during the taxable year” may be deducted if it is not compensated for by insurance or otherwise. Section 165(a), however, limits this broad rule by restricting an individual’s deductions to:
1. Losses incurred in a trade or business or a transaction entered into for profit; and
2. Losses “from fire, storm, shipwreck, or other casualty, or from theft.”
The “theft loss,” which only includes losses to property not connected with the taxpayer’s trade or business or for-profit transactions, and is further restricted by rules denying the deduction for the first $500 (2009)of loss from each casualty and allowing losses above this floor only to the extent they exceed 10 percent (10%) of adjusted gross income (IRC §165(h)). The courts have found a further limitation implicit in Section 165(a) – that a casualty loss is not allowable in any part if the deduction would frustrate well-defined public policy.
(See, Blackman v. CIR, 88 TC 677, 682 (1987) – taxpayer intentionally set fire to wife’s clothes and negligently allowed fire to spread to entire house; held no casualty loss deduction because deduction “would severely and immediately frustrate the articulated public policy … against arson and burning,” even though taxpayer never charged with crime; Mazzei v. CIR, 61 TC 497 (1974) – taxpayer defrauded by co-conspirators in scheme to counterfeit U.S. currency; held, theft loss of participant in criminal activity not deductible; Rev. Rul. 82-74, 1982-1 CB 110 (where taxpayer, in order to collect insurance, paid another to burn down taxpayer’s building, public policy, precludes amount paid from being taken into account in determining gain on building’s conversion). However, see, Hossbach v. CIR, 42 TCM (CCH) 80 (1981) [public policy not offended by allowing deduction for destruction by explosion of building used by taxpayer to manufacture illegal drugs]. IRC § 641(b) rules make § 165(c) apply to trusts and estates.)
Since losses attributable to business and profit-oriented property are deductible regardless of cause, the principal significance of the deduction allowed by § 165(c)(3) for casualty losses is that it encompasses personal residences, private automobiles, jewelry, home furnishings, and other property owned and used for personal purposes. Property of this type does not qualify for depreciation deductions while the taxpayer owns it, and losses on sales of such property are also nondeductible. (Reg. § 1.165-9(a).) If the property is damaged or destroyed by casualty, however, the resulting loss may be deducted under § 165 (c)(3).)