Now that Bernie is in the poky and we all feel a lot safer, how do investors treat their losses for tax purposes.  The IRS has recently released two Revenue Rulings to help.  This ruling applies to all “ponzi” losses not just Bernie’s mess. 

The IRS released Rev. Rul. 2009-9 addressing the tax treatment of "Ponzi" scheme losses, and Rev. Proc. 2009-20 which provides safe harbor options for deducting these losses. This is a safe harbor rule, which mean it is not law just guidance.  The guidance is welcome relief to the thousands of investors who have lost money in the Bernard Madoff scandal and others who have incurred similar Ponzi scheme losses.

The revenue ruling states that the losses are considered theft losses not subject to casualty loss limitations under §165(h) or the itemized deduction limits under §67 and §68. The rulings will allow the losses against ordinary income and goes so fare that it even allows an NOL generated by Ponzi losses to be treated as sole proprietorship losses potentially eligible to be carried back 3, 4, or 5 years under the business tax breaks enacted by the American Recovery and Reinvestment Act of 2009.  This is good news that the losses are not treated as capital losses because they would only be eligible for a maximum deduction of $3,000 a years until the losses are used up.

The safe harbor options under Rev. Proc. 2009-20 allow a 95% deductible loss for investors with no potential third-party recovery or a 75% deductible loss for investors with potential third-party recoveries. The investor may have additional losses or income in later years depending on actual recoveries. The returns in those years would reflect the actual loss and be reported accordingly.

This ruling my also apply to the 1031 exchange industry where several qualified intermediary companies lost client’s proceeds while held in escrow.   

Dave Owens, CPA, CES, is the managing member of Entrust Freedom, LLC and can be contacted at owens@entrustfreedom.com or 239-333-1031.  The Entrust Group is an national administrator of Self Directed Retirement Plans.