When Crypto Scam Losses Aren’t Fully Deductible: What a DOJ Seizure Changes for Your Taxes

Cryptocurrency scams have become more common and more costly.

For years, many victims were told the same thing: once the funds were gone, recovery was unlikely. From a tax perspective, that often meant treating the loss as a full theft-loss deduction.

That assumption is starting to change.

Recent enforcement actions by the Department of Justice (DOJ) and the FBI are leading to partial recoveries in some cases. 

While that is a positive development, it also creates a more complex tax situation, which needs to be handled carefully.

A Crypto Scam Case: What Happens When Funds Are Seized

In a recent matter handled by Attorney Sammy Kim, a 65-year-old taxpayer lost approximately $1 million in a cryptocurrency scam tied to an investment platform.

After being told he needed to pay additional “fees” to withdraw his funds, he realized the situation was fraudulent and reported the incident through the FBI’s IC3 system.

Unlike many prior situations, this case developed differently.

The DOJ was able to identify the criminal group and seize a portion of the stolen funds before they were moved offshore. Nineteen victims were identified, and each was assigned asset IDs tied to their losses.

Affected individuals were instructed to submit petitions within a specific timeframe to claim their portion of the recovered assets.

At this stage, there is a reasonable expectation of recovery of approximately $300,000 out of the $1 million loss.

Why This Changes the Tax Treatment

This is where many taxpayers – and even some advisors – get it wrong.

A theft loss is generally deductible under Internal Revenue Code Section 165. 

However, the deduction is limited to the amount that is not expected to be recovered.

If there is a reasonable prospect of recovery, that portion must be excluded from the deduction.

This is not optional. Overstating the deduction can create issues later if funds are recovered.

In practical terms, as applied to this case, the numbers look like this:

• Total loss: $1,000,000
• Expected recovery: $300,000
• Deductible loss: $700,000

Timing Matters: Why Filing an Extension Is Often the Right Move

One of the most important decisions in this type of case is when to file the return.

In this case, the recommended approach was to fix an extension for the client’s taxes for 2025.

That allows time to:

• Monitor the DOJ recovery process.
• Better estimate the recoverable amount.
• Avoid prematurely claiming a deduction that may later need to be corrected.

The recovery process is not immediate. It can take months, or longer, for funds to be distributed.

Filing too early increases the risk of overstating the deduction if some of the funds are later recovered, which can create complications down the line.

How the Deduction Is Ultimately Calculated

By the extended tax deadline, the goal is to determine the portion of the loss that is not reasonably recoverable.

That amount is reported on Form 4684 (Casualties and Thefts).

Key considerations include:

• Any amount with a reasonable recovery expectation must be excluded.
• The IRS may review these deductions during examination.
• State tax treatment typically follows the federal position.

Even after filing, these cases may be reviewed within the standard three-year statute of limitations.

Why This Area of Tax Law Is Evolving

Historically, crypto scam losses were often treated as total losses due to the difficulty of recovery.

That assumption is becoming less reliable as enforcement agencies improve their ability to trace transactions, identify criminal networks, and seize funds, leading to more cases involving partial recoveries.

The IRS has also begun addressing these issues more directly in recent guidance related to cryptocurrency scams and recovery efforts.

That shift directly impacts how theft-loss deductions should be handled.

What to Do If You’ve Experienced a Crypto Scam

If you’ve been affected by a cryptocurrency scam, there are a few immediate steps to take:

• Report the incident (e.g., FBI IC3, police report, email or call financial institutions)
• Preserve all documentation and communications
• Determine whether any recovery process is underway
• Coordinate closely with your tax advisor before filing

Most importantly, avoid assuming that the entire loss is deductible.

Get Help With Your Crypto Scam Case

If you’ve experienced a crypto-related loss and want to understand your options, including whether recovery may be possible, contact the Law Offices of Sammy Kim for help now.

Each situation is different, and the timing and structure of your filing can have a significant impact on the outcome.

Frequently Asked Questions About Crypto Scam Cases

Can I deduct the full amount of my crypto loss?

Not necessarily. If there is a reasonable expectation that some of the funds will be recovered, that portion must be excluded from the deduction.

What counts as a “reasonable expectation of recovery” in a crypto scam case?

That depends on the facts of the case. If law enforcement has identified assets, seized funds, or initiated a recovery process, that may create a reasonable expectation.

Should I wait to file my taxes if recovery is possible?

In many cases, filing an extension is advisable. That allows time to better understand how much, if any, of the loss may be recovered.

What happens if I deduct the full loss and later receive funds?

You may need to amend your return or report the recovery as income, potentially with interest implications depending on timing.

Will the IRS review crypto scam loss deductions?

These deductions are often reviewed and you are likely to receive inquiry letters from the IRS, particularly when large amounts are involved. Proper documentation and accurate calculations are important. 

Will my state tax returns allow similar crypto scam loss deductions?

These deductions may only be allowed on your federal tax returns and not necessarily on your state tax returns. Every state is different in allowing deductions. You should talk to tax professionals who are familiar with your state’s limitations.