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‘Reasonable Certainty’ for a Theft Loss Deduction

IRC § 165 allows taxpayers to deduct theft and other casualty losses, but requires them to take reasonable action to recover those losses.

October 2007
from Journal of Accountancy

The Internal Revenue Code often requires the calculation of amounts that are less than absolute but more than mere guesses. IRC § 165 allows taxpayers to deduct theft and other casualty losses but requires them to take reasonable action to recover those losses. If a claim for reimbursement has a reasonable prospect of recovery, the loss is not treated as sustained “until the taxable year in which it can be ascertained with reasonable certainty whether or not such reimbursement will be received.” Treas. Reg. § 1.165-1(d)(3); see also Jeppsen v. Commissioner, 128 F.3d 1410 (10th Cir. 1997).

“Incorrigible Optimism” Not Required

What is reasonable certainty? “A reasonable prospect of recovery exists when the taxpayer has bona fide claims for recoupment from third parties or otherwise, and when there is a substantial possibility that such claims will be decided in his favor.” Jeppsen, quoting Ramsay Scarlett & Co. Inc. v. Commissioner, 61 TC 795, 811 (1974), aff’d, 521 F.2d 786 (4th Cir. 1975). The taxpayer is not required to be an “incorrigible optimist,” United States v. S.S. White Dental Mfg. Co., 274 U.S. 398, 402–03 (1927), and claims with only “remote or nebulous” potential will not postpone the deduction (Ramsay Scarlett). Whether a reasonable prospect of recovery exists is determined by reviewing all facts and circumstances. Treas. Reg. § 1.165-1(d)(2)(i).

“Credible Evidence” Required

It is settled law that deductions are a matter of legislative grace, and the taxpayer must prove that he or she is entitled to the claimed deductions. INDOPCO Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). “The law does not require that they [damages] be determined with mathematical certainty. It only requires that damages be capable of measurement based upon known reliable factors without undue speculation.” Ashland Management Inc. v. Janien, 82 N.Y.2d 395, 604 N.Y.S.2d 912 (1993).

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