Choosin’ Texas: U.S. Tax Court Bails Out “All Hat, No Cattle” Investor

Background
The taxpayer operated a jewelry business in Laredo. He started going on hunting and fishing trips with two customers, Lamberth and Visel. And while the taxpayer was focused on what critters he could kill, the customers clearly had the taxpayer in their sights. Between 2001 and 2004, the taxpayer invested over $250,000 with these broke bad cowboys and received nothing back.

Well, bless our taxpayer’s heart because several years later, when they told him they needed $350,000 to open a Swiss bank account in order to receive a $70 million funds transfer, he ponied up $175,000 on the promise the money would be returned in two months. You might have thought that the taxpayer then realized that this was not his first rodeo with these guys because (of course) the money was not returned. But the taxpayer did not seek to recover his money. Instead, 15 months later, he gave them another $200,000 to facilitate the same account opening. When this came to naught, he invested another $350,000. It goes without saying that foreign princes were alleged to have been involved. Can’t make this stuff up.

At this point the taxpayer began to realize that the investment scheme was cattywampus. So, in 2010, he paid a consultant $50,000 to tell him that “the deal was likely a fraud.” After some feeble attempts to collect the money, the taxpayer claimed a deduction on his 2010 federal income tax return for theft losses. No charges were ever filed against the fraudsters and there is no indication that the taxpayer ever filed litigation against them either. They just rode away into the sunset.

The Theft Loss Deduction
The Tax Code permits a theft loss deduction for losses sustained on a transaction entered into for profit but not incurred in a trade or business.^[3] The deduction is deferred until the taxpayer no longer has a reasonable prospect of recovery and must be claimed in the year in which it is discovered.^[4] A theft loss includes a loss sustained by swindling and larceny, as determined under local law.^[5] The Tax Court has held, however, that a tort claim for fraud or negligent misrepresentation does not support a theft loss deduction under Code 165(a).^[6] Texas law governed whether the facts established whether the taxpayer was swindled. Under Texas law, the taxpayer would have suffered a theft loss if the taxpayer had been deceived in turning over the money to Lamberth and Visel.

The Internal Revenue Service (IRS) disallowed the theft loss deduction because it did not find that the taxpayer had proven that he advanced the money in circumstances that established criminal fraud. While a theft conviction may establish conclusively the existence of a theft under Code § 165(e), the lack of such a conviction does not necessarily preclude a theft loss deduction, provided that the requisite criminal intent to deprive is present.^[7] After a full court trial, the taxpayer was able to convince the Tax Court that the swindlers’ “coaxing of [the taxpayer] to make multiple bank transfers” were multiple acts of deception amounting to criminal fraud under Texas law. The court adopted a lax standard for the taxpayer to prove the loss. In contrast to other cases, the court accepted the fact that no one could account for the money that the taxpayer transferred as sufficient evidence of misappropriation.^[8] But the court couldn’t even pinpoint who the thief was.^[9] The court concluded that the taxpayer discovered the fraud in 2010, when he hired the financial consultant and, despite his pleas to be repaid as late as 2013, he had no reasonable expectation of recovery after 2010.^[10] Accordingly, the Tax Court held for the taxpayer that he was entitled to a 2010 loss deduction.

The taxpayer in Deutsch fared significantly better than other taxpayers faced with similar facts. For example, in Baum v. Comm’r,^[11] the taxpayer lost over $300,000 in a stock purchase scheme. In that case, like Deutsch, the taxpayer asserted that the loss resulted from fraud in the inducement. The court conceded that the taxpayer had been defrauded under relevant local law (California). He claimed the loss in 2015, the year in which the fraudster filed for bankruptcy. The bankruptcy concluded in 2019. The court held that in 2015 it was not clear that the taxpayer wouldn’t be able to recover any money. As a result, it disallowed the deduction for 2015. It’s not clear how the taxpayer in Deutsch had better facts than the taxpayer in Baum.

Take Aways
One hopes that the taxpayer now recognizes that not everyone in a Stetson 10-gallon hat and Lucchese cowboy boots can be trusted. But for the rest of us, the lessons may be more prosaic. There’s no need to get a move on because an unknown foreign prince needs your money to open his bank account. Even when an investment is made with personal friends, documentation should establish all material terms and conditions so that if it does go awry, it will be easy to establish that there was fraud in the inducement. When it appears that an investment may be part of a fraud, it’s important to act on suspicions sooner rather than later and establish that the investor has made every effort to recover the amounts advanced in the scheme.

Although Mark Leeds is a tax partner in the New York office of Pillsbury, he had the honor of attending the University of Texas at Austin for part of his undergraduate education. Mark’s professional practice entails work with various private investment structures, and while he always works to ensure that all of his clients have investment successes, it’s best practice to prepare for the worst.

^{[1] T.C. Mem. 2026-66 (August 12, 2026).}

^{[2] See Code § 68(c)(3).}

^{[3] Code § 165(a).}

^{[4] Code § 165(e).}

^{[5] Treas. Reg. § 1/165-8(d).}

^{[6] Singerman v. Comm’r, T.C, Summary Op. 2005-4. A theft loss requires a criminal appropriation of another's property. Bellis v. Commissioner, 61 T.C. 354, 357 (1973), aff’d 540 F.2d 448 (9th Cir. 1976); Harcinske v. Commissioner, T.C. Memo. 1984-132.}

^{[7] See Vietzke v. Comm'r, 37 T.C. 504, 510 (1961) (holding that a theft had occurred for purposes of Code § 165(e), even though the alleged perpetrator of the theft was not convicted of a theft crime).}

^{[8] Compare Jeppsen v. Comm'r, 128 F.3d at 1418 (10th Cir. 1997) (noting taxpayers are "not entitled to take the theft loss deduction" in a year if the "prospect of recovery was simply unknowable").}

^{[9] Other courts have held that if a taxpayer is unable to establish the elements of the crime of theft under the applicable state law, the taxpayer cannot be allowed a deduction under Code § 165. See Rochlis v. Comm’r, 146 Fed. Cl. 743 (2020). The Federal Circuit in Krahmer concluded that under 26 U.S.C.  § 165, the "appropriate burden is proof by a preponderance of the evidence." Krahmer v. United States, 810 F.2d 1145 (Fed. Cir. 1987); see also Bunch v. Comm'r, T.C.M. 2014-177, Marine v. Comm'r, 92 T.C. 958, 976 (1989); Allen v. Comm'r, 16 T.C. 163, 166 (1951).}

^{[10] For a not dissimilar case that denied the theft loss see Baum v. Comm’r, T.C. Mem. 2021-46.}

^{[11] T.C. Mem. 2021-46.}