IRS 2025 Memorandum: When Crypto and Investment Scam Losses Are Actually Deductible
In 2025, the IRS Office of Chief Counsel issued a major memorandum addressing a question that thousands of scam victims have been asking:
If I was defrauded, can I deduct my losses?
The answer is yes in many cases, but only if specific legal conditions are met.
The full IRS memorandum can be reviewed here:
https://www.irs.gov/pub/irs-wd/202511015.pdf
For cryptocurrency investors, brokerage account holders, IRA owners, and victims of phishing or account takeover schemes, this guidance is one of the most important developments in recent years.
At Coin Counsel, we represent victims of crypto exchange failures, pig butchering scams, phishing attacks, SIM swaps, and unauthorized account takeovers. This IRS analysis directly impacts how those losses are treated for tax purposes.
Below is a detailed breakdown of what the IRS clarified, what it means, and what victims need to understand before filing a return.
The Legal Framework: Section 165 Theft Losses
Internal Revenue Code Section 165 allows taxpayers to deduct losses sustained during the taxable year that are not compensated by insurance or otherwise.
For individuals, the deduction is limited to three categories:
Losses incurred in a trade or business.
Losses incurred in a transaction entered into for profit.
Casualty or theft losses not connected to business or profit.
Here is the critical complication.
From 2018 through 2025, the Tax Cuts and Jobs Act largely eliminated personal casualty and theft deductions unless tied to a federally declared disaster.
That means if your loss is considered personal, it is likely not deductible.
If your loss is considered investment related, it may be deductible.
The difference turns on motive.
What Counts as Theft for Tax Purposes
The IRS confirmed that theft is interpreted broadly. It includes criminal appropriation of property through fraud, deception, false pretenses, or embezzlement.
To qualify for a theft loss deduction:
The taking must be illegal under state law.
The loss must be discovered in the year claimed.
There must be no reasonable prospect of recovery at year end.
That final requirement is often misunderstood.
A taxpayer does not need to prove recovery is impossible. The question is whether, based on the facts available at the end of the year, there was little or no reasonable prospect of recovery.
For many crypto scams involving unidentified overseas actors, that standard may be satisfied relatively quickly.
The Central Question: Was the Transaction Entered Into for Profit
This is where everything turns.
The IRS drew a sharp distinction between transactions entered into for profit and those motivated by personal reasons.
If funds were invested, reinvested, or intended to generate income, the loss may fall under Section 165(c)(2) and be deductible.
If funds were transferred for emotional, personal, or family reasons, the loss is considered a personal casualty loss and is disallowed under current law.
The analysis focuses on the taxpayer’s motive at the time of the transaction.
Investment and Crypto Scams: Generally Deductible
The IRS examined several types of scams that are common in the digital asset space.
Compromised Account Impersonation Scam
In this scenario, a scammer impersonates a fraud specialist and convinces the victim that their investment accounts are compromised.
The victim authorizes distributions from IRA or brokerage accounts and transfers funds into what they believe are secure or replacement investment accounts.
The IRS concluded that this type of loss may be deductible because the taxpayer’s motive was to safeguard and reinvest funds. The transaction retained a profit motive.
This is highly relevant to victims who:
Moved crypto into a so called secure wallet at the direction of a scammer.
Transferred funds to what appeared to be a legitimate exchange.
Followed instructions from someone impersonating an exchange or custodian.
Intent matters.
Pig Butchering Crypto Investment Scam
In this scenario, the victim is lured into a cryptocurrency platform promising large returns.
After small withdrawals build trust, the victim transfers larger sums from IRA or brokerage accounts. Eventually, withdrawals are blocked and the platform disappears.
The IRS concluded that these losses may be deductible.
Why?
Because the transaction was clearly entered into for investment purposes. The taxpayer had a profit motive.
This directly mirrors many modern crypto fraud cases.
Phishing and Unauthorized Withdrawals
In another scenario, the taxpayer did not authorize any transfer. The scammer gained access to accounts and drained them.
The IRS still allowed a deduction.
The reason is critical. The stolen property consisted of investment assets originally held for profit. Even though the final transfer was unauthorized, the underlying property was connected to a profit motivated investment.
This is extremely important for:
Exchange account takeover victims.
SIM swap victims.
Hacked wallet victims.
Even unauthorized theft can qualify if the underlying property was held for investment.
Romance and Ransom Scams: Generally Not Deductible
The IRS also analyzed situations involving emotional or personal transfers.
Romance Scam
If a victim transfers funds to someone posing as a romantic partner in need of assistance, the loss is not deductible.
The transfer was motivated by personal reasons, not investment or profit. Under current law, that makes the loss a nondeductible personal casualty loss.
Kidnapping or Ransom Scam
If a victim transfers funds under duress to protect a family member, the loss is also not deductible.
Even though the circumstances are tragic, the motive is personal, not profit driven.
The IRA Trap: Taxable Income Even When Stolen
One of the harshest aspects of this guidance concerns retirement accounts.
If a victim authorizes an IRA distribution before the funds are stolen, the distribution is still taxable.
Even if the money is immediately transferred to a scammer.
Even if the victim never benefits from the funds.
While a theft loss deduction may be available for the amount stolen, income recognition still occurs when retirement funds are distributed.
This creates a devastating double impact:
Loss of principal.
Income tax liability on distributed retirement funds.
Victims must carefully analyze the tax consequences before filing.
The Ponzi Safe Harbor Rarely Applies to Modern Crypto Scams
The IRS also addressed the Ponzi loss safe harbor.
To qualify, there must be a specific fraudulent arrangement and a lead figure charged by indictment or criminal complaint.
Most modern crypto scams involve unidentified actors operating overseas.
As a result, the safe harbor generally does not apply.
Victims must rely on standard theft loss analysis instead.
Practical Guidance for Crypto Victims
If you were defrauded in 2024 or 2025, ask yourself:
Were the funds invested or intended to produce profit?
Was the loss discovered in the year claimed?
Is there little or no reasonable prospect of recovery?
Do you have documentation of the scam?
Were retirement funds involved?
Documentation is critical and should include:
Exchange account statements.
Wallet addresses and transaction confirmations.
Communications with the scammer.
Law enforcement reports.
Communications from financial institutions regarding recovery prospects.
The IRS makes clear that this is a fact driven analysis.
Final Thoughts
The IRS has now confirmed that many crypto and investment scam victims may deduct their losses under Section 165, but only when the transaction was entered into for profit and there is no reasonable prospect of recovery.
The distinction between investment motive and personal motive is decisive.
For crypto investors, phishing victims, SIM swap victims, and account takeover victims, this guidance provides clarity, but it also exposes risks, especially involving retirement accounts.
If you have suffered a crypto related theft, both tax strategy and legal strategy matter.
Coin Counsel represents victims nationwide in crypto arbitration, exchange disputes, and digital asset litigation. If you believe your loss may qualify for a theft deduction or you are pursuing recovery against an exchange, we can help you evaluate your options and protect your rights.
Precision matters. In crypto, precision protects you.
