Q: I contracted for construction of a home. The builder did a terrible job, although he did make a few repairs. I sued the builder, but the company was out of business and I was out of luck. It cost me over $100,000 to repair the house. Can I claim a theft loss on my tax return?
A: You may have some additional options in your effort to collect, such as convincing a court there is sufficient reason to disregard the corporate shell and hold the principal personally liable. However, it is unlikely you will be able to claim your loss as a theft deduction for income tax purposes.
Theft is generally defined as knowingly taking or using property of another with intent to either temporarily or permanently deprive the other person of right to the property. Theft includes such crimes as larceny, embezzlement and robbery.
Theft losses deductible for Federal Income Tax purposes are not limited to the statutory crime of theft. However, the loss must be the result of a crime under state law. That means the ability to deduct a loss can depend on the state where the loss occurs.
Cases interpreting the theft deduction can be confusing. For example, money obtained under false pretenses that is considered fraud under state law is deductible as a theft loss. Yet, where a person buys stock based on misrepresentation of the financial condition of the corporation and the value of the stock declines, a theft loss has been denied even where the officers of the corporation were prosecuted for the misrepresentation. Victims of a pyramid or Ponzi scheme may be entitled to a theft loss.
To quality as a deductible theft loss, the taxpayer must prove that the property was actually stolen. Many taxpayers claiming a theft deduction have found that does not equal stolen.
As for your particular situation, similar facts were recently addressed by the tax court in the case of Wanchek v. Commissioner. The Wancheks had construction problems. Although the builder made an effort to repair their home, things seemed to get worse. Four years after the house was built, the Wancheks sued the builder claiming negligence, misrepresentation, fraud, unfair trade practices, breach of warranty, breach of duty of good faith and fair dealing, and breach of contract.
The Wancheks eventually settled their suit, receiving a payment from the builder as part of a settlement agreement that stated no party admitted “any responsibility or wrongdoing whatsoever.” No criminal charges were ever filed against the builder.
After their suit was settled, the Wancheks attempted to claim a theft loss on basis that the builder committed fraud, as defined by the laws of New Mexico. The Wancheks claimed the builder took their money with intention not to build a house in accordance with the plans. The IRS argued the Wancheks could not prove fraudulent intent because their builder had obtained a permit, hired sub-contractors, was on site on a daily basis, obtained a certificate of occupancy and even attempted to repair deficiencies after the home was built.
The Tax Court agreed with the IRS and held that the Wancheks failed to show their builder had specific intent to cheat or deceive them when he took their money. The court explained breach of contract or negligence by the builder did not equate to theft.
Although you may not be able to claim a theft deduction, other deductions may be available as might additional avenues to collect from your builder or those associated with the builder. You should consult with an experienced attorney promptly to explore possible options.
William G. Morris is an attorney with offices at 247 North Collier Boulevard, Marco Island. His practice covers a broad range of subjects, including civil litigation, real estate, business and corporate law, estate planning and probate, domestic relations and contracts. He writes this column periodically with respect to legal matters that frequently affect non-lawyers. The information contained in this column is not intended as legal advice and, of necessity, is generalized. For questions about specific circumstances, the reader should consult a qualified attorney. Questions for this column can be sent to William G. Morris, email: email@example.com, or by fax, (239) 642-0722.