Deducting Investment Losses As Thefts
Another one of the many unfair double standards in the tax code is the treatment of capital gains and losses. Gains are fully taxable each year with no maximum amount to be added to other kinds of income. On the other hand, net capital losses have a ridiculously low limit on how much can be deducted each year against other types of income.

This limit has been $3,000, with no adjustments for inflation, for decades. I have worked with a number of clients who felt this injustice in a big way with the dot-com stock market bubble. They showed huge taxable gains for a few years, and then when the bubble burst, huge losses, which have to be parceled out at $3,000 per year. I seriously doubt if one client, who is in his seventies, will live long enough to be able to use the more than one million dollars in capital losses he suffered from the stock market meltdown. Another inequity in the tax code is that, when you pass away, all unused capital and other tax losses just disappear. They aren't passed on to the heirs.

To get around this idiotic limit on deducting just $3,000 of investment losses per year, some people came up with the idea of recharacterizing the losses as fully deductible thefts due to dishonest stockbrokers or corporate management. Services, such as this one, popped up to help people document this alleged theft for tax purposes. I remember writing about such services a number of years ago and hadn't even thought about them until this morning, when I received a faxed copy of a recent solicitation from 165 Services from a helpful CPA in Ohio, Dana Stahl.

I checked out this service's website again and see that they are still as vague about the details as they were when I last reviewed them a few years ago. I sent them a request for clarification of how the fee for their 100+ page report is determined; whether it is a flat amount, an hourly rate, or a percentage of the loss or the taxes saved. I have yet to hear back from them. My gut feeling is that they probably base their fee on the taxes saved by being able to deduct the full loss in the first year instead of the measly $3,000 that would be allowed on Schedule D. I will post an update if that is proven to not be the case.

If that is how these folks charge for their report services, I have doubts as to its legality with IRS. Their service seems to be quite similar to that of an appraiser who establishes values of assets used for tax calculation purposes, such as items donated to charities or assets in a person's estate. As indicated here on the IRS website, it has long been forbidden for appraisers providing such valuation services to base their fees on the values they calculate. Such an arrangement would entail the same kind of conflict of interest as if we tax preparers based our fees as a percentage of the refunds we show on the returns; another illegal action under IRS regulations.

Prohibited appraisal fee. Generally, no part of the fee arrangement for a qualified appraisal can be based on a percentage of the appraised value of the property. If a fee arrangement is based on what is allowed as a deduction, after Internal Revenue Service examination or otherwise, it is treated as a fee based on a percentage of appraised value.

I also have my doubts as to how far the concept of a theft can be stretched to cover stupid investment choices. Over my 28+ year career, I have seen plenty of churning of clients' accounts by stockbrokers who were more interested in earning commissions than in preserving the clients' wealth. However, as dishonest as the public impression is of stockbrokers, corporate executives, and mutual fund managers; most of the losses in the stock market are probably just from idiotic decisions by people falling for the glamour of get rich quick financial gurus. I'm not sure where you cross the line from being the victim of stupidity to one of an outright actionable (and deductible) theft. However, for the right fee, it seems like these folks will give you a report claiming that it was a theft.


- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 2/16/2004 08:04:00 PM Send this post: