Specialist US UK Tax Services: Investment Fraud Theft Loss

An American living in the UK who loses money to an investment fraud can usually claim a US theft-loss deduction under section 165, because the money was placed in a transaction entered into for profit. Ponzi-type losses may use the IRS safe harbour in the year charges are filed. UK relief is far narrower and often unavailable.

That asymmetry is the heart of the problem. Our Specialist US UK Tax Services team at Jungle Tax prepares both returns for UK-resident Americans who discover that an investment they trusted was never what it appeared to be. This guide explains, in compliance terms, how the loss is measured, which year it belongs to, how the IRS safe harbour works, what happens to any excess as a net operating loss, how later recoveries are taxed, and why HMRC will often give little or nothing for the same economic loss. It is written for readers who have already instructed lawyers and want the tax reporting done correctly the first time.

Why does a fraud loss get different treatment on each side of the Atlantic?

The United States taxes its citizens on worldwide income regardless of residence, and its Internal Revenue Code contains a specific deduction for losses arising from theft. The UK taxes residents through a schedular system that has no general theft-loss relief for private investors. HMRC relief depends on the loss fitting one of its existing boxes: a capital loss on the disposal of an asset, a negligible value claim on an asset that still exists, or one of a handful of narrow income-tax reliefs for specific types of shares or loans.

For a UK-resident American, this means the same seven-figure loss may produce a substantial ordinary deduction on Form 1040 and a modest, ring-fenced capital loss, or nothing at all, on the UK Self Assessment return. Because the US-UK income tax treaty does not create a theft-loss relief of its own, and the treaty's saving clause preserves the US right to tax its citizens, each country's rules must be applied separately and then reconciled through the foreign tax credit mechanism.

The US position: section 165 and the post-2017 landscape

Personal theft losses were suspended, but investment theft losses were not

The Tax Cuts and Jobs Act limited personal casualty and theft losses, those under section 165(c)(3), to losses attributable to federally declared disasters for 2018 through 2025, and later legislation made that restriction permanent. That change does not reach losses under section 165(c)(2): losses incurred in a transaction entered into for profit. Money handed over in the belief that it was being invested, whether into a fund, a managed account, a private note programme or a digital-asset trading platform, will usually fall into this category.

The IRS Office of Chief Counsel confirmed this distinction in Chief Counsel Advice 202511015, released in March 2025. It analysed several common scam patterns and concluded that victims who transferred funds with a profit motive, including fake investment platforms and schemes where a victim was persuaded to move money to "protect" an existing investment account, could generally claim a theft loss, while victims of purely personal scams, such as romance scams where no profit motive existed, could not. The National Taxpayer Advocate published a helpful summary on the Taxpayer Advocate Service blog.

What counts as a theft?

Theft for section 165 purposes is a broad concept covering any taking of property that is illegal under the law of the jurisdiction where it occurred and done with criminal intent, including embezzlement, swindling and obtaining property by false pretences. A conviction is not required, but the taxpayer must be able to show that a theft actually occurred. Losses caused by poor investment decisions, market falls or a promoter's negligence are not theft losses, however painful. Where an investment simply collapsed, the loss is normally a capital loss on a worthless security, which is far less valuable for most high earners.

Why the characterisation matters so much

The IRS set out the core treatment of Ponzi-type losses in Revenue Ruling 2009-9. The key conclusions remain the foundation of every return we prepare in this area:

• Ordinary, not capital. A theft loss in a profit-seeking transaction is an ordinary loss, so it can offset salary, bonus, carried interest taxed as ordinary income, dividends and interest, rather than being capped at $3,000 a year against ordinary income as net capital losses are.
• No personal-loss floors. The $100 per-event reduction and the 10% of adjusted gross income threshold that apply to personal casualty losses do not apply.
• Not a miscellaneous itemised deduction. The deduction is reported on Schedule A as an "other itemised deduction", so it is not lost under the suspension of miscellaneous itemised deductions subject to the 2% floor, and it is not subject to the overall limitation on itemised deductions.
• Phantom income is included. Fictitious "returns" that you reported as income in earlier years, and did not withdraw, are added to the amount of the loss.
• Net operating loss eligibility. To the extent the deduction exceeds income, it can create a net operating loss.

Measuring the loss

The deductible amount is, broadly, your basis in what was stolen: cash invested, plus any fictitious income previously reported and reinvested, minus every withdrawal you received, minus any reimbursement you have received or for which there is a reasonable prospect of recovery. For UK residents, each sterling or euro contribution must be translated into US dollars at the exchange rate on the date it was paid, and each withdrawal at the rate on the date received. Over a long investment period, currency movements alone can shift the deductible figure by a meaningful percentage, so the contribution and withdrawal schedule should be rebuilt from bank statements rather than from the scheme's own (fictitious) account statements.

Which year is the deduction claimed in?

Under the general rules, a theft loss is deductible in the year the taxpayer discovers it. If, in that year, a claim for reimbursement exists with a reasonable prospect of recovery, the portion that may be recovered is deferred until the year it can be ascertained with reasonable certainty whether it will be received, for example when litigation is settled, a liquidator makes a final distribution or the claim is abandoned.

This "reasonable prospect of recovery" test is the source of most disputes. Claim too early and the IRS may argue the loss was not yet fixed; claim too late and the deduction may belong to a year that is already closed under the statute of limitations. For victims who are still waiting on liquidators, receivers and civil claims, the uncertainty can last many years. That is the problem the safe harbour was designed to solve.

How does the IRS Ponzi safe harbour work?

Revenue Procedure 2009-20, as modified by Revenue Procedure 2011-58, offers an optional, simplified route for qualified investors in a "specified fraudulent arrangement", essentially an arrangement in which the lead figure receives cash from investors, purports to earn income for them, reports fictitious income, and uses new investors' money to pay withdrawals or for personal use.

The conditions

• The lead figure must have been charged by indictment, information or criminal complaint under state or federal law with a crime that amounts to theft, or, under the 2011 modification, in certain circumstances where the lead figure has died, been the subject of a civil complaint or had the arrangement placed in receivership alleging the elements of a specified fraudulent arrangement.
• The investor must not have had actual knowledge of the fraud before it became known to the public.
• The investment must not have been made through a fund or other entity that is itself the investor; in that case the entity, not the individual, claims the loss and the individual's position depends on the fund structure.

The "discovery year" and the 95% / 75% rule

The safe-harbour deduction is claimed in the "discovery year": the tax year in which the indictment, information or complaint was filed. The deductible amount is your qualified investment multiplied by:

• 95% if you are not pursuing any potential third-party recovery; or
• 75% if you are pursuing, or intend to pursue, a third-party recovery, typically a claim against a bank, auditor, feeder fund or other adviser outside the fraudulent group,

and then reduced by any actual recovery and any potential insurance or investor-protection recovery. The remaining 5% or 25% is not lost: it is deducted later, when the outcome of the recovery claims becomes certain.

The procedural requirements are strict

To use the safe harbour you must mark the top of Form 4684 with a reference to the revenue procedure, complete Section C of Form 4684, attach the signed statement set out in the procedure's appendix, and agree not to amend earlier years to remove the fictitious income you previously reported. The Tax Court has held that a taxpayer who claimed on the return for a later year, rather than the discovery year, could not use the safe harbour at all. In practice, a UK-resident American whose US returns have fallen behind is particularly exposed to this timing trap, because the discovery year may be a year for which no return has yet been filed.

Safe harbour or general rules?

The safe harbour trades precision for certainty. It removes arguments about the year of deduction and the reasonable-prospect test, but it caps the first-year claim and forecloses amending earlier years. Taxpayers with a strong case for a larger or earlier deduction, or who would benefit more from amending prior years to remove phantom income still within the limitation period, should model both routes before deciding. The election is made per arrangement, so an investor caught by two separate frauds can choose differently for each.

Net operating losses: what happens to the excess?

For most fraud victims, the theft loss far exceeds income in the discovery year. The excess becomes a net operating loss. Under the post-2017 rules, NOLs arising in tax years beginning after 2020 generally cannot be carried back; they are carried forward indefinitely and may offset no more than 80% of taxable income in each later year. The former three-year carryback that individuals once enjoyed for theft losses no longer applies to current-year losses, although losses arising in 2018, 2019 and 2020 were subject to temporary five-year carryback rules.

For an American resident in the UK, this creates an interaction that generalist guidance never addresses. Most UK-resident Americans pay little or no US tax because UK tax on the same income is credited against US tax through the foreign tax credit. An NOL is applied against taxable income before credits, so it may be absorbed in years where your US liability would have been nil anyway. The deduction is real, but its cash value depends on how much of your income is US-source or otherwise not fully sheltered by UK tax credits, for example US-situs investment income, gains taxed at higher US rates than UK rates, or income taxed in the UK under a different timing rule. The allocation and apportionment of a large deduction can also reduce your foreign tax credit limitation and increase carryforwards. Careful modelling across several years is essential before choosing between the safe harbour and the general rules, and before deciding the year in which to claim.

How are later recoveries taxed?

Recoveries are common: liquidators and receivers often make distributions over a decade, and third-party litigation can settle years after the fraud came to light. Under the US tax-benefit rule, a recovery of an amount previously deducted is included in gross income in the year received, to the extent the earlier deduction reduced your tax. You do not amend the earlier return. If you used the safe harbour, recoveries first reduce the deferred 5% or 25% balance before any income inclusion arises.

Clawback claims add a further layer. Where a liquidator recovers "fictitious profits" that you withdrew in earlier years, repayment may itself be deductible, and the claim of right doctrine under section 1341 has been considered in this context, although the IRS view in Revenue Ruling 2009-9 is that section 1341 does not apply to the theft loss itself. Each recovery or repayment should be logged with its date, currency and exchange rate, because it will need to be reflected on both the US and the UK returns.

The UK position: why HMRC relief is so much narrower

No general theft-loss relief for private investors

UK tax law does not contain a direct equivalent of section 165. A private individual who is defrauded cannot simply deduct the loss from income. Relief, if any, has to be found within the capital gains rules or a specific income-tax relief, and each of those requires facts that a fraud often lacks.

Capital losses and negligible value claims

Where you genuinely acquired an asset, such as shares in a company that turned out to be the vehicle for a fraud, units in a fund that was looted, or tokens actually delivered to your wallet, and that asset becomes worthless while you own it, you can make a negligible value claim. This treats you as having sold and immediately reacquired the asset at its negligible value, crystallising a capital loss. The claim can specify a deemed disposal date up to two tax years before the year in which the claim is made, provided the asset was already of negligible value at that earlier date. HMRC's helpsheet HS286 explains the mechanics.

The resulting capital loss can only be set against capital gains of the same year or carried forward against future gains. It cannot reduce employment income, dividends or interest. For a founder or executive whose wealth is largely income, a UK capital loss may sit unused for years.

Where nothing existed, there may be nothing to claim

The deeper difficulty is that in many frauds no asset ever existed. If you transferred money to an account controlled by a fraudster who purported to buy investments but never did, you did not acquire a chargeable asset that later became worthless. You may instead hold a right of action or a debt against the fraudster. In UK capital gains tax, a loss on a simple debt held by the original creditor is generally not an allowable loss, and the specific relief for irrecoverable loans is confined to loans to traders used in a trade. Theft itself is not treated as a disposal. The practical result is that HMRC frequently allows no relief at all for the portion of a loss that the US treats as fully deductible.

Income-tax relief: rarely available

Share loss relief, which lets certain capital losses be set against income, is restricted to shares you subscribed for in qualifying unquoted trading companies, including EIS and SEIS shares. Fraudulent vehicles rarely meet the trading and qualifying conditions. Losses on investments in a genuine business that later failed through a director's fraud are a possible exception and are worth examining carefully.

Phantom income already taxed in the UK

If you reported fictitious returns as interest or gains on earlier UK returns, those amounts were never actually received. Whether, and for which years, any of that UK tax can be reclaimed depends on the facts and on the four-year time limit that applies to most UK overpayment claims. This needs to be considered early, because the window closes year by year while recovery proceedings continue.

US and UK treatment compared

Documenting the loss on both returns

Whether the claim is made under the general rules or the safe harbour, the evidential burden is on you. We recommend assembling a single loss file that serves both returns:

• A dated schedule of every contribution and withdrawal, sourced from your own bank records, with the currency, exchange rate and dollar equivalent of each entry.
• Copies of all statements issued by the scheme, kept to identify fictitious income previously reported, not to prove value.
• Evidence that a theft occurred: police or Action Fraud crime reference numbers, regulator notices, charging documents, court filings, receivership or liquidation notices.
• A record of every recovery avenue considered or pursued, including claims against the scheme, insurers, investor-compensation schemes and third parties, and the status of each at each year-end.
• For UK purposes, evidence of what asset, if any, you acquired, when it became of negligible value, and the date specified in any negligible value claim.
• Copies of prior-year US and UK returns showing how the scheme's "income" was reported.

On the US side, the loss is computed on Form 4684 and carried to Schedule A, with any NOL calculated and tracked from year to year. On the UK side, any negligible value claim and capital loss are reported on the capital gains pages of the Self Assessment return, and a capital loss must be claimed within four years of the end of the tax year in which it arose. IRS Publication 547 and HMRC's Capital Gains Tax guidance are the starting points, but neither addresses the cross-border interaction.

Compliance gaps that a fraud often exposes

Fraud investigations frequently uncover reporting gaps that pre-date the loss. Money may have been held in non-US accounts in your name, triggering FBAR and Form 8938 reporting for the years it was there. A scheme structured through a non-US company or fund may have required Forms 5471 or 8621. US returns may simply have lapsed after a move to the UK. Because the theft-loss deduction must be claimed in the correct year, and the safe harbour is lost entirely if the discovery-year return is wrong, these gaps should be closed in the same exercise. Where the failures were non-wilful, the IRS Streamlined Filing Compliance Procedures can often bring an American abroad back into compliance while the theft-loss position is established, and our FBAR penalty calculator gives a first view of the exposure.

A worked illustration

Consider a US citizen resident in London who, over six years, transferred the dollar equivalent of $4.2 million into a private investment programme, withdrew $900,000, and reported $650,000 of fictitious interest on US returns that was reinvested. The promoter is charged with fraud in a US federal court in the current year. No third-party claim is planned.

• Qualified investment: $4.2m + $0.65m - $0.9m = $3.95m.
• Safe-harbour deduction in the discovery year: 95% x $3.95m = about $3.75m, less any actual or potential insurance or investor-protection recovery.
• US effect: the deduction eliminates taxable income for the year, and the excess becomes an NOL carried forward. Its cash value depends on future US-source and under-credited income, which must be modelled.
• UK effect: because the programme never acquired any asset in the client's name, there is likely no negligible value claim and no capital loss. The UK tax paid on the fictitious interest in recent years may be reviewable within the time limits.

The figures are illustrative only, but the pattern is typical: a large and valuable US deduction, little or no UK relief, and a timing decision that cannot be undone once the discovery-year return is filed.

How Jungle Tax helps

We prepare US and UK returns side by side for affected clients, reconstruct contribution and withdrawal histories in both currencies, model the safe harbour against the general rules across multiple years, compute and track the NOL, and prepare negligible value claims where an asset genuinely existed. Where earlier filings are missing, we bring them up to date first so that the theft loss lands in the correct year. Clients whose wider affairs are complex can draw on our high-net-worth tax team and our dedicated US UK tax accountants. We prepare returns and compliance filings; we do not pursue recoveries or give investment advice, and we work alongside your litigation counsel.

If you have discovered that an investment was a fraud, the most valuable decision is often made in the first few months, before the discovery-year return is filed. Speak to us in confidence: contact our cross-border team to arrange a confidential consultation and a review of both your US and UK filing positions.