Received a 1099-misc for lawsuit for loss of capital / investment. How do I show the loss from the investment to counter the income on 1099-misc?

[carlwh]

I have a 1099-misc from a lawsuit against a company for a fraudulent investment where we did not get our money back, and if we do get any money back it will not be near what we paid. I should be able to counter the income from the 1099-misc with the losses on the investment. I had not written off the investment yet since we will at some point get part of the money back. This 1099-misc will not make us whole so there will be some more losses once we know how much might get returned to us. Where do I, and how do I show theses losses. I don't want to write off all the losses since we might get some of it back. How can I show the losses for the amount of the lawsuit in turbo tax where they will cancel each other and the IRS will know the lawsuit was for loss of our capital on an investment? Thank you. 

[Opus 17]

Your question is still a bit unclear.

You made an investment.  When, how much, what kind of company?  Were you a partner, a shareholder, an investor only?

You received a partial settlement, and the company sent a 1099-MISC?  

You expect to receive more money in the future, but you expect the total received will be less than the amount invested?

[carlwh]

In 2014, we bought 3 $20K life settlements from Pacific West Capital Group. California shut them down for fraud. You can google it if you need more info, class action lawsuit  SEC v. Pacific West Capital Group, Inc.

We were part investors in these 3 life insurance policies.

We will receive a 1099-misc for $7683 for 2023 in Jan 2024 from the PWCG 

All the life insurance policies for all investors were put into a conservatorship and are being managed until the policies still active pay out. We will get our share when they pay out. There were policies lost before they were put in the conservatorship, so we will not receive our total $60K.

I have already bought 2023 TurboTax to calculate our total income for 2023 to determine how much I can do in Roth conversions. So I need to know if I will be able to write off this income with losses from these investments, and how to show this in TurboTax so the IRS will know this income was loss of capital from these investments? 

[Opus 17]

@DoninGA  @rjs  @TomD8 

This is a bit of a puzzle.  You are getting 1099-MISC from the state, presumably, because the state is managing the payments.  Here are my thoughts, but I welcome the advice of other experts.

The payments are not taxable income at the time they are received, until and unless they exceed the amount you originally invested.  There is a way to zero them out in Turbotax so they won't be added to your income, but you will want to have an explanation prepared in case the IRS asks questions.  

Then, whenever you receive the final payment and the resolution fund is closed, with no more payouts coming, one of two things will happen.

a. This is an investment loss.  At the the time the final investments become worthless or the resolution fund is closed, you will report a capital loss on schedule D.  You will report the amount of the original investment, and report it as a "sale", using the date the resolution fund closed, and the selling price is the amount of proceeds you received over time.  You will be able to deduct the remaining capital loss against future capital gains.  But you can't declare any investment loss until the final amount is known.

b. This is a theft loss.  For 2018-2025, theft losses are not tax deductible.  You simply collect whatever restitution you can get, and walk away.  The restitution is not taxable income, but the remaining loss is not deductible.  However, if the tax law changes, and the final loss occurs in a year when theft losses are deductible, you might be able to deduct the theft loss.  (On the other hand, if the theft occurred between 2018 and 2025, the loss might never be deductible even if the law is different when the final payments are made, I'm not sure on this point.)  (Since there is a fraud conviction, I think it is more likely the IRS will want you to treat this as a theft loss than an investment loss.)

Note that if you received periodic payments from this investment, and paid income taxes on those investment "gains" (which later turned out to be fake), you have a Ponzi scheme loss, not an ordinary theft loss, and Ponzi scheme losses are still deductible under current tax law (because you paid income tax on money that was never really yours).  However, deducting Ponzi losses is complicated and you may need to see a tax professional. 

[carlwh]

That was all very goo info, but it did not tell me how I can do this within turbotax.  So the class action lawsuit check was not from the state, 3 investors started the lawsuit.  So you said that I could counter the 1099-misc income, but you did not tell me how I can do that within turbotax? I know I need to add the 1099-misc. But how do I counter the income in turbotax, and put in comments on why this income should not be taxed so the IRS will understand?

Thank you,

[TJ_ttax]

@Opus 17  @DoninGA  @rjs  @TomD8 

Opus (or others),

1.  Can you please share the method within Turbotax by which it is possible to  A) "zero them out in Turbotax so they won't be added to your income" and B) 'but you will want to have an explanation prepared in case the IRS asks questions. "?   

I am in a similar boat and am inclined to adopt Opus' Option A approach, effectively applying the 1099-misc and other future recovery provided by the receivership against the investment basis.  However, since this particular check was from an associated lawsuit settlement (https://ethreeadvisors.com/project/shecter-et-al-v-mills-potoczak-company-pc-et-al/) vs. direct investment proceeds, it was reported as 1099-misc, and therefore it is unclear to me how to offset this, as TT and the IRS will treat this money as income vs. capital gain.

2. It also concerns me that the regulations for lawsuit settlement seem very sparse and lean mostly towards personal injury and/or punitive damages instead of the compensatory damages which I think applies here.  I found this old audit guide (https://www.irs.gov/pub/irs-utl/lawsuitesawardssettlements.pdf) which suggests that IRC 1001 exception could apply to IRC 61, but does not go into detail regarding applicable situations. 

If you or anyone can share any other/better references that seem to apply to this situation, it would be most appreciated.  

Thank you!!!!

[RobertB4444]

If you are adopting option A then you believe this is an investment loss.  If it is an investment loss, as @Opus17 says above you can't enter the amount of loss until the final payout is received and the total is known.  Then it is entered as a sale of an investment that has become worthless with a basis of the amount that you invested and a sale price of the amount that you recovered.

If, as in the example above, you received a partial payment in anticipation of a further payout down the line, you can't close out the investment yet.  You will have to wait until the final payout is received.  

So you can enter the 1099-MISC in the system as it has been received along with a corresponding negative amount under miscellaneous income that will zero out your income for this payment.  The description would be 'return of investment capital' or something like that.  Then, when you do close out the investment, you will need to reduce the basis for the investment loss by the amount that you received in this initial payment.  

@TJ_ttax 

[TJ_ttax]

Great, thank you so much for the feedback.  This makes the most sense to me as I don't believe this should be treated as pure income nor should it be completely tax free, but instead should be incorporated into the basis/return of the investment.  By following the instructions here (https://ttlc.intuit.com/community/taxes/discussion/1099-misc-box-3-other-income/00/2402716#:~:text=Y....),

TT shows the offset with my explanation right below the reported 1099-misc entry in schedule 1.  

I will continue to follow this thread in case there is any other input, but if none this seems a viable approach to address this situation.  Thank you!!

@RobertB4444