A tricky one: Ponzi capital loss reporting options...
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Level 2

A tricky one: Ponzi capital loss reporting options and decisions

We got taken in what ended up being declared a Ponzi scheme, although the financial aspects were settled via a court negotiated agreement (with, as usual, lawyers being the only ones who profited 😉 ).

I will keep this generic, so it applies more broadly.

I see several important questions/decisions, none of which are simple:

1) Date of loss

2) Basis of investment

3) Amount of loss

4) Type of loss (ordinary bad-debt, S/T capital, L/T capital)


To make it even more complex, there is a radical difference between:

a) The basic financial numbers reported on a final K-1

b) The basic same numbers, documented by the Court-Appointed Receiver (and agreed to by all parties.)

(These are so different, the K1 for example shows a basis much higher than what we invested, and final year business losses that are also over the top.)


In my case, I'm a not-well-paid nonprofit worker. Not owing much fed tax no matter what right now... but sure would like to at least preserve some tax deduction value into the future if nothing else.


MY QUESTION: Does my thinking below make sense, on the choices and ways to report this?



- Normally, the loss date is the date they determined there was an issue.

- BUT: if there is a possibility of a return, I'm required to wait until that's settled -- ie a determination is made that a return is likely, even if not known how much or exactly when.

- In this case, the hammer came down for them back in 2016, but it was July 31, 2020 when I was told how much I lost, and was told "someday" we would likely receive "some money". Heh.


DECISION: I plan to report this for 2020.



- This should be simple. We invested $nn,000. And that's what the Court says too.

- But the final K-1 says our basis is more than $10k higher.


DECISION: My gut sense is to trust and Do Not Argue with the Court. Perhaps add an attachment explaining my decision.

(I've done many attachments before 😉 )



- The court gave a loss amount

- But any $$ I get back reduces the loss

- I do NOT want to pay tax on the refund of my own money...


DECISION: I plan to report a loss at or below a level sufficient to cover any refund



a) The IRS allows a Ponzi Safe Harbor choice. That seems nice until one looks at the details in context.

---- the loss with this method becomes a Bad Debt loss, reportable as an itemized deduction

---- With the new rules about itemizing and std deduction, I'd have to lose a boatload of bucks for this to make ANY difference at all

--- AND, any "excess" just blows away in the wind.


b) I see IRS (section 166) rules saying that an investment loss of this type, once the date is known, should be reported as a short term capital loss.

--- I like this for my situation. I do get capital gains sometimes...and AFAIK this would carry forward until used up.


DECISION: I plan to report this as a S/T capital loss, using overrides as needed in turbotax to get there. (QUESTION: is there a btter way to do this?)



- I plan to basically ignore the K1 I received (months after the Court accounting) and trust the Court numbers

- Oh, the K1 is also a Final K1, and for 2019. I'd have to amend last year's to report that way... and it would have zero financial impact. I.e., would not save me a dime.

- I assume I need to write an attachment for my return to explain what I did with that and why.

(Honestly the K1 appears to be from outer space, not matching anything else ever seen.)


THOUGHTS? I hope this makes sense... and even may be helpful to someone else.

1 Reply
Expert Alumni

A tricky one: Ponzi capital loss reporting options and decisions

You will want to document your position for differing from the Final K1 and attach to your tax return. The IRS does not have the benefit of knowledge of the lawsuits' facts and circumstances  nor does it have to have to accept its findings.  

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