Taxing Lessons Case Summaries

Case — Theft Loss

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TL Case Summ

THE QUESTION

Can a taxpayer claim a theft loss when a building contractor finishes a home but fails to follow contract specifications during the construction?

THE DISPUTE

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.

THE LAW

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

For the or for the

THE COURT’S DECISION

Download (PDF, 17KB)

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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.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!
For the IRS. No deduction allowed. Though the quality of the house was substandard, it was built, and later repairs were made. Taxpayers did not prove specific intent on the part of the contractor to cheat or deceive them when he took their money in exchange for building the house.
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