Generally investment losses are capital losses. Capital losses can only be deducted to the extent of capital gains for the year, plus another $3,000 ($1,500 if you use married filing separate status). Any balance capital losses get carried forward to the following year, and is subject to similar limitation in future years.
Hence, it can take years to fully deduct huge capital losses.
In contrast, ordinary losses can be written off against any other type of income. Also, If you have a big ordinary loss that exceeds the income for the year, the excess will result in net operating loss which can be carried back to previous years and/or carried forward to offset income in future years.
IRS now allows Ordinary Loss Treatment for Ponzi-Scheme Victims
According to IRS Revenue Ruling 2009-9 and IRS Revenue Procedure 2009-20, the ordinary loss from a Ponzi investment scheme can be written off as an itemized deduction (on Schedule A of Form 1040) as Casualty and Theft Losses.
Note that-
· It can be deducted in full without regard to the limitations that apply to personal theft losses.
· It can be deducted in full without regard to other rules that reduce write-offs for other types of itemized deductions.
· It can be deducted in full under the alternative minimum tax (AMT) rules.
· It can be deducted on Form 1040 for the year in which you discover the loss. However, the loss must be reduced by claims for reimbursement for which you have a reasonable prospect of recovery.
· Losses that create a net operating loss can be carried back to the three previous years or forward to the next 20 years. You may also be able to carry back a net operating loss created by a 2008 Ponzi loss for up to five years.
· Losses are deductible in the year in which the loss was suffered. Determining the amount and timing of losses from these schemes is difficult and dependent on the prospect of recovering the lost money timing of losses from these schemes. Hence IRS now allows you to deduct a safe-harbor loss amount on the return for the year that the loss is discovered. The safe-harbor privilege is only allowed for losses discovered after 2007. IRS Revenue Procedure 2009-20 simplifies compliance for taxpayers by providing a safe-harbor means of determining the year in which the loss is deemed to occur and a simplified means of computing the amount of the loss.