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IRS Regulations for Investors Who Are Defrauded


Fortunately for those who fall prey to Ponzi schemes and the like, the IRS does allow for the losses to be deducted from annual tax returns. Of course, investors must follow certain regulations, and not everyone will be permitted to take the deduction. Tax guru Julian Block discusses IRS regulations on capital gains and losses and more. 

Sep 30th 2021
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Just joining us? Go back to part one for a summary of how the notorious Bernard Madoff orchestrated a Ponzi scheme that stole more than $50 billion from investors. Madoff’s clients were a who’s who of financial outfits, well-endowed philanthropies and ultra-wealthy persons including A-listers and boldface names.

Part one also touched on some highlights of the IRS guidelines that authorize unprecedented tax relief for victims of Madoff-type schemes and other too-good-to-be-true investment ruses. It also discussed safe harbor provisions that ensure favorable treatment for investors. Part two will focus on other aspects of these guidelines, including safe harbors and restrictions on special relief eligibility.

Internal Revenue Code Section 1211. As noted in part one, the IRS guidelines treat losses from Ponzi and other schemes as theft losses deductible in accordance with Section 165. They are not treated as investor losses deductible in accordance with Section 1211, which imposes severe limitations on capital losses.

Section 1211 allows investors to offset all of their capital losses and capital gains from sales or redemptions of stocks, bonds, mutual funds or ETFs. However, that relief is of little to no help for most investors when profits are scarce, as they were when Madoff’s scheme was revealed in 2008. 

What if there aren’t any gains or losses that exceed gains? This is where Section 1211 comes in, since it authorizes limited relief. Investors are able to use as much as $3,000 (dropping to $1,500 per person for married couples filing separate returns) of their net losses as deductions against ordinary income. This wide-ranging category includes salaries and other forms of compensation, pensions, interest and “dividends” (considered interest) paid on savings accounts, certificates of deposit or similar savings vehicles.

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