8712 / When is a taxpayer entitled to take a deduction for a theft loss?
Editor’s Note: Under the 2017 tax reform legislation, individuals are no longer entitled to deduct casualty and theft loss expenses as itemized deductions for 2018-2025 (when those losses are not related to property used in a trade or business). An exception exists for losses that occur in federally declared disaster areas.1
A taxpayer who sustains a theft loss may take the deduction for the tax year in which the taxpayer discovers the loss, rather than the year in which the loss was sustained (as is the general rule for casualty losses).2
The reasonable prospect of recovery doctrine (see Q 8716) applies in the case of theft losses,
so that the taxpayer will not be entitled to take a deduction if there is a claim for reimbursement against a third party that may fully or partially compensate the taxpayer for the theft loss, and there is a reasonable prospect that the taxpayer will recover these amounts.3 These rules do not apply to a theft loss discovered through a shortage in the inventories of a business.4
The amount of the taxpayer’s theft loss deduction is determined using the same method applicable to casualty loss deductions (see Q 8713).
Example: Denise purchased a watch for $15,000 in 2012. In 2015, the watch, which now has a fair market value of $13,500, is stolen. Denise does not discover that the watch is missing until 2016. Though the watch was insured against theft, the insurance company challenges its liability for the loss. Despite this challenge, Denise has a reasonable prospect of recovering from the insurance company in 2016. In 2017, Denise settles with the insurance company and receives $12,000 in insurance proceeds to cover the theft loss. Denise is not permitted to take a deduction in 2015 or 2016, but in 2017, she is permitted a theft loss deduction for $1,500. The computation is made as follows:
Value of property immediately before theft................................................................... $13,500
Less: value of property immediately after theft............................................................. $0
Balance........................................................................................................................... $13,500
Loss to be taken into account for purposes of Section 165(a)....................................... $13,500
Less: insurance received in 2017.....................................................................................$12,000
Deduction allowable for 2017 ........................................................................................ $1,500