Replies to post #227380 on CMKM Diamonds Inc. (fka CMKX)

[Investorman]

It looks like a capital loss is all that can be taken.

a deduction is allowed under § 165(a) if the stock is worthless and has no recognizable value. A decline in the value of stock owned by the taxpayer is not allowed as a deduction under § 165(a) until the taxable year in which the loss is actually sustained as a result of the sale or exchange of the stock or the stock becoming wholly worthless.

Whether a loss constitutes a theft loss is determined by examining the law of the state where the alleged theft occurred. Edwards v. Bromberg, 232 F.2d 107, 111 (5th Cir. 1956); Viehweg v. Commissioner, 90 T.C. 1248, 1253 (1988). Thus, to claim a theft loss, the taxpayer must prove that the “loss resulted from a taking of property that is illegal under the law of the state where it occurred and that the taking was done with criminal intent.” Rev. Rul. 72-112, 1972-1 C.B. 60.

In cases involving stock purchased on the open market, the courts have consistently disallowed theft loss deductions relating to a decline in the value of the stock that was attributable to corporate officers misrepresenting the financial condition of the corporation, even when the officers were indicted for securities fraud or other criminal violations. In Paine v. Commissioner, 63 T.C. 736, aff’d without published opinion, 523 F.2d 1053 (5th Cir. 1975), the taxpayers claimed a theft loss deduction for a decline in value of stock stemming from misrepresentations of the financial status of the corporation by corporate officials. The court noted that the taxpayers did not purchase the stock from the corporate officers who made the misrepresentations, but on the open market. In MTS International Inc. v. Commissioner, 169 F.3d 1018 (6th Cir. 1999), an individual taxpayer sold at a loss stock that was acquired on a public stock exchange and argued that the substantial decline in value was due to criminal conduct by the corporation’s officers. The Sixth Circuit concluded that the loss was not a theft loss.

Accordingly, the Service will disallow a deduction for a theft loss under § 165(a) relating to a decline in the value of stock that was acquired on the open market for investment. If the stock is sold or exchanged or becomes wholly worthless, any resulting loss is a capital loss.