Tax Court denies theft loss and upholds penalty over Turks and Caicos casino investment
Potts v. Commissioner, T.C. Memo. 2025-108, No. 14941-18, 2025 BL 370997, 2025 Tax CT Memo Lexis 114, Court Opinion
The Tax Court rejected a claimed section 165 theft loss tied to a Turks and Caicos casino investment and sustained a section 6662 accuracy-related penalty.
A taxpayer cannot claim a theft loss for funds paid to a selling shareholder where no theft under applicable foreign law is proven and the taxpayer was not the owner of any misappropriated funds.
Holding
The Tax Court held that Craig and Kristen Potts did not prove a deductible theft loss under section 165 related to their 2008 purchase of Carib Gaming shares.
The court found no theft under Turks and Caicos law, concluded that any alleged misappropriation would have been of VT Enterprises’ funds rather than the taxpayers’ property, and sustained a section 6662 accuracy-related penalty.
The decision will be entered under Rule 155.
Why It Matters
Confirms that theft loss claims turn on the law of the jurisdiction where the loss occurred and require proof of each statutory element.
Clarifies that purchasing existing shares from a seller does not give the buyer ownership of the seller’s sale proceeds for theft loss purposes.
Emphasizes the need for contemporaneous writings when taxpayers rely on alleged promises about how sale proceeds will be used.
Reinforces documentation and advisor-opinion requirements for reasonable cause defenses to penalties.
Timeline
2001: Petitioners begin investing in Turks and Caicos gaming businesses.
April to June 2008: Memorandum of Understanding and Share Purchase Agreement executed. Petitioners acquire 25 percent of Carib Gaming for 2.5 million dollars.
2009 to 2010: On personal statements, petitioners report Carib Gaming income and value their interest at 6 million dollars.
2014: Petitioners acquire the remaining Carib Gaming shares from VT Enterprises for 225,000 dollars and execute a release. They become aware of unpaid local gaming taxes.
2014: Petitioners file a return claiming a 2 million dollar theft loss and report zero federal income tax liability.
May 7, 2018: IRS issues a notice of deficiency disallowing the theft loss and asserting a section 6662 penalty.
June 5, 2024: Court addresses evidentiary issues in an order and invites briefing on two exhibits.
October 16, 2025: Tax Court issues a memorandum opinion disallowing the theft loss and sustaining the penalty.
Key Facts
Petitioners invested in Turks and Caicos gaming operations, including a bar with routed slot machines.
In 2008, they purchased 25 shares of Carib Gaming from VT Enterprises for 2.5 million dollars via a stock sale, not a capital contribution to Carib Gaming.
Governing agreements did not require VT Enterprises to reinvest sale proceeds in Carib Gaming or the planned casino project.
Petitioners received dividends and other payments from Carib Gaming after 2008.
In 2014, petitioners purchased VT Enterprises’ remaining shares for 225,000 dollars and executed a release of claims.
Petitioners claimed a 2 million dollar theft loss on their 2014 return, asserting that Carib Gaming principals had diverted 2 million dollars of their 2008 purchase price.
The record lacked admissible expert testimony on Turks and Caicos law and lacked corroborating banking or wire documentation of a misappropriation.
Statutory or Regulatory Framework
Section 165 allows individuals to deduct losses not compensated by insurance only if incurred in a trade or business, a transaction for profit, or due to casualty or theft. A theft loss is generally taken in the year of discovery. Treasury Regulation section 1.165-1 outlines substantiation and timing.
Whether a theft occurred is determined under the law of the jurisdiction where the loss happened. The Turks and Caicos Theft Ordinance defines theft as dishonest appropriation of property belonging to another with the intent to deprive, and separately defines theft by deception permanently.
Section 6662 imposes a 20 percent accuracy-related penalty for negligence or substantial understatement. Section 6751(b) requires written supervisory approval. Section 6664(c) provides a reasonable cause exception.
Federal Rules of Evidence 801(d)(2)(D) governs admissions by a party’s agent or employee.
Arguments
Taxpayers argued:
A theft occurred when 2 million dollars of their 2008 purchase price was diverted by Carib Gaming principals, contrary to representations about funding a casino buildout.
The loss was discovered in 2014 and properly deducted then.
They acted in good faith with professional preparation of the return.
IRS argued:
No theft occurred under Turks and Caicos law because the 2008 stock sale agreements did not restrict the seller’s use of sale proceeds, and there were no false statements of existing fact.
Even if funds were diverted, the property belonged to VT Enterprises, not the petitioners, so the petitioners were not the proper party to claim a theft loss.
The section 6662 penalty applies, and supervisory approval was satisfied. No reasonable cause was shown.
Court’s Reasoning
The court applied Turks and Caicos law to determine whether a theft or theft by deception occurred.
The appropriation element failed. Petitioners bought existing shares from VT Enterprises, and none of the agreements required the seller to contribute proceeds to Carib Gaming. The proceeds were VT Enterprises’ property.
Petitioners received exactly what they purchased, namely 25 shares, and later dividends and distributions, which undercut a claim of misappropriation of petitioners’ property.
There was no credible proof of deception as to the existing fact. Alleged promises about future intentions to fund a casino project were not written, were superseded by the integration clause, and did not establish theft by deception.
The court found the alleged 2014 confession testimonial account unpersuasive and uncorroborated. The court excluded one exhibit and admitted another under the party-opponent admission rule, but those evidentiary rulings did not change the outcome.
Petitioners did not provide expert testimony on Turks and Caicos law or banking records to substantiate diversion or timing.
Even if misappropriation occurred, the entity that owned the diverted funds would be the proper party to claim any theft loss. That would be VT Enterprises or possibly Carib Gaming, not the petitioners.
The burden of proof did not shift under section 7491. Petitioners did not substantiate or cooperate to the level required.
The IRS met its burden of production for the penalty, including section 6751(b) approval. Petitioners did not establish reasonable cause. There was no evidence that the return preparer advised on the theft loss or that the petitioners provided the necessary information for such advice.
Forward-Looking Implications
Taxpayers claiming foreign-law theft losses should secure admissible expert testimony on the specific foreign statute and its elements.
Buyers who acquire stock from existing owners should not expect theft loss treatment tied to how sellers use sale proceeds, absent contractual restrictions in the governing agreements.
Integration clauses and lack of written commitments will weigh against theft by deception theories premised on oral promises.
Reasonable cause defenses for complex loss positions require documented advisor analysis addressing the specific legal standard and facts.
Ownership and control of funds at the time of alleged misappropriation are central to who may claim a theft loss.
Result
The court disallowed the section 165 theft loss deduction and sustained the section 6662 accuracy-related penalty. The decision will be entered under Rule 155.
The Takeaway
Stock purchases from existing shareholders do not convert the seller’s use of proceeds into a theft of the buyer’s property, absent binding restrictions. Theft loss claims grounded in foreign law require precise evidence, proper party analysis, and contemporaneous documentation.
List of Citations
Section 165 and Treas. Reg. section 1.165-1. Defines theft loss requirements and timing.
Turks and Caicos Theft Ordinance, c. 3.10, sections 2.1, 3, 24.1, 31. Defines theft, theft by deception, and false statements by company officers.
Section 6662, section 6664(c), section 6751(b). Accuracy-related penalties, reasonable cause, and supervisory approval.
Monteleone v. Commissioner, 34 T.C. 688. Determines theft by reference to local law.
Paine v. Commissioner, 63 T.C. 736, aff’d, 523 F.2d 1053. Theft loss based on misrepresentations of existing facts.
First Chicago Corp. v. Commissioner, T.C. Memo. 1995-109. Theft loss where fraudulently misstated financials induced capital infusion.
McComb v. Commissioner, T.C. Memo. 1977-176. Theft loss where the promisor never intended to perform.
Malik v. Commissioner, T.C. Memo. 1995-204. Proper party requirement for theft loss.
Tokarski v. Commissioner, 87 T.C. 74. Uncorroborated testimony may be disregarded.
Graev v. Commissioner, 149 T.C. 485. Supervisory approval for penalties.
Higbee v. Commissioner, 116 T.C. 438. Burdens and reasonable cause.
Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, aff’d, 299 F.3d 221. Reliance on professional advice standard.
Fed. R. Evid. 801(d)(2)(D). Admissions by an agent or employee.