Can a taxpayer claim a theft loss when a building contractor finishes a home but fails to follow contract specifications during the construction?
Taxpayer Says: Although the house was completed, a theft loss deduction is allowable because the contractor committed fraud by taking money for the construction while intending to ignore contract specifications.
Internal Revenue Service Says: This is a contractual dispute that does not rise to the level of theft, so no deduction is allowable.
From Internal Revenue Code Section 165(a): A taxpayer can deduct any loss sustained during the taxable year that is not compensated for by insurance or otherwise.
From Internal Revenue Code Section 165(c)(3): Limits losses for individuals, and allows an individual taxpayer to deduct losses of property arising from, among other things, theft.
From Monteleone v. Commissioner, 34T.C. 688, 692-694 (1960): The existence of a theft must be determined by reference to the law of the jurisdiction in which the loss occurred; however, a criminal conviction is not necessary in order for a taxpayer to demonstrate a theft loss.
From McCullough v. Commissioner, T.C. Memo. 1990-653: The New Mexico Criminal Code does not specifically make ‘theft’ a crime.
From N.M. Stat. Ann. sec. 30-16-6: The elements of criminal fraud include “a specific intent to cheat or deceive someone.”
THE CAUSE OF THE DISPUTE
To claim a theft loss, taxpayers must prove the loss resulted from a taking of property that is illegal under the law of the state where it occurred (New Mexico in this case) and that the taking was done with criminal intent.
In this case, after the contractor’s attempts at repair failed to fix the defects, the taxpayers filed a civil lawsuit against him (and other parties). Taxpayers agreed to a settlement of $130,000 before trial. The settlement contained no admission of wrongdoing on the part of the contractor, and no criminal charges were filed.
WHAT WOULD YOU DECIDE?
Make your selection, then see “The Court’s Decision” below for a full explanation
THE COURT’S DECISION
HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.
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