Step 5: If the investor has a reasonable prospect of recovery, determine whether the investor qualifies under the safe harbor under Rev. Proc. 2009-20 (the Madoff Rules).
Rev. Proc. 2009-20 allows certain investors to claim a theft loss deduction under I.R.C. § 165 for qualified losses from certain fraudulent investment schemes. Under section 4.02 of Rev. Proc. 2009-20, a qualified loss is a loss from a specified fraudulent arrangement (defined in Section 4.01) for which authorities have charged the lead figure by indictment, information, or criminal complaint with a crime that meets the definition of theft for purposes of I.R.C. § 165.
Rev. Proc. 2009-20, Section 4.02 defines a qualified loss as a loss resulting from a specified fraudulent arrangement in which, as a result of the conduct that caused the loss:
(1) A lead figure was charged by indictment or information under state or federal law with the commission of fraud, embezzlement, or a similar crime that, if proven would meet the definition of theft for purposes of § 165 of the Internal Revenue Code and
§ 1.165-8(d) of the Income Tax Regulations under the law of the jurisdiction in which the theft occurred, and the indictment or information has not been withdrawn or dismissed (other than because of the death of the lead figure); [or]
(2) The lead figure was the subject of a state or federal criminal complaint (not withdrawn or dismissed) alleging the commission of a crime described in section 4.02(1) of this revenue procedure, and either –
(a) The complaint alleged an admission by the lead figure or the execution of an affidavit by that person admitting the crime; or
(b) A receiver or trustee was appointed with respect to the arrangement, or assets of the arrangement were frozen.
If the investor does not qualify under Rev. Proc. 2009-20, because a criminal complaint has not been filed by a governmental entity, we assist the client in the preparation of a police report which describes how the promoter induced the taxpayer to depart with their property by swindling, false pretenses, embezzlement, or deceit.