Last summer, I invested $5,000 to be a member of an LLC. A month later, I saw that the business was not doing well so I told the owner I did not want to sign the contract and he said that he would repay me $5,000 when he has it because he spent it for his personal use. A week later, he took $1,200 from the business checking account, left the business and moved to Reno. It was later found out he had embezzled $20,000 over a six month period from the company and a police report was filed. Am I able to deduct my $5,000 loss as a capitol loss on my tax return and if so would it be listed as a bad debt or bad investment?

ANSWER

The BIDaWIZ Team's Answer:

Was this considered to be a Ponzi-scheme? This will dictate whether or not the loss will have limitations or not. Assuming that this loss is the result of a Ponzi-scheme, the loss may be claimed as a full deduction to ordinary income as referenced in IRC Section 165(h). The loss would be reported via Schedule 4684 - Section C and is governed by the Internal Revenue Ruling 2009-20. If the loss is not determined to be part of a Ponzi Scheme, then it will be deductible as a Schedule A itemized deduction for a casualty loss. Unfortunately, casualty loss deductions are subject to some limitations, so the entire loss wouldn't be deductible.