Theft Losses and Legal Fiction

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When you think of legal fiction, best-selling authors such as John Grisham and Scott Turow may come to mind—and if you’re a tax preparer, you might want to add Judge Francis M. Allegra of the US Court of Federal Claims to your list. In Goeller v. U.S., (Ct Fed Cl 3/20/2013), Judge Allegra writes of a long-entrenched legal fiction dealing with theft losses and the federal income tax code.

According to the US Court of Federal Claims, “theft” has a long-standing and well-accepted meaning. The court references Black’s Law Dictionary, which defines the term as “[t]he fraudulent taking of corporeal personal property belonging to another, from his possession, or from the possession of some person holding the same for him, without his consent, with intent to deprive the owner of the value of the same, and to appropriate it to the use or benefit of the person taking.” [Black’s Law Dictionary 1647-48 (4th ed. 1951)]

In treasury regulations, the term “theft” is “deemed to include, but shall not necessarily be limited to, larceny, embezzlement, and robbery.”

If you’ve suffered a theft loss as defined by those rules, you can claim a deduction on your federal income tax return. When there’s a disagreement between the IRS and taxpayers over whether a theft loss is allowable, courts—including the US Tax Court—look to state law to determine whether a theft actually occurs.

According to the Court of Federal Claims, adding that deciding factor is a non sequitur—a legal fiction.

In Goeller, the taxpayers claimed a theft loss from an investment in a private real estate venture that went bankrupt. The taxpayers lived in California and the real estate venture was based in Ohio, leading to a dispute with the IRS as to which state’s laws were controlling.

The Court of Federal Claims says both parties are wrong to look to state law. Instead, the court says a uniform, common-law definition is applicable. “The court sees no reason why this rule ought not apply to section 165(c)(3). Certainly, nothing in the statutory language, its legislative history, or the relevant Treasury Regulations suggests otherwise.”

The case may not read as easily as a novel of legal fiction. Nonetheless, it’s an interesting tale, and since the Court of Federal Claims is a trial court of original jurisdiction whose authority is on par with the Tax Court, tax preparers might want to skim through the very informative reasoning.

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