Joseph B. Leonard and Dorothy A. Cole Leonard - Page 9

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          Robert.  Petitioners contend that Robert embezzled money from them,         
          and as a result thereof, they sustained a $650,000 theft loss in            
          1985 that would entitle them to a net operating loss carryover              
          deduction in 1988.  Respondent contends that petitioners provided           
          money to Robert to assist him and Suzette, and that petitioners             
          knew at least by 1984 that the money would not be repaid.3                  
               Individual taxpayers may deduct certain losses, including              
          theft losses, sustained during the taxable year and not compensated         
          for by insurance or otherwise.  Sec. 165(a), (c)(3).  A theft loss          
          is deductible in the year in-which the taxpayer discovers the loss.         
          Sec. 165(e).  Petitioners have the burden of proving a theft loss.          
          Rule 142(a); Malik v. Commissioner, T.C. Memo. 1995-204.                    
               The term "theft" includes embezzlement.  Sec. 1.165-8(d),              
          Income Tax Regs.  Whether a theft occurred depends on the law of            
          the State where the loss was sustained.  Paine v. Commissioner, 63          
          T.C. 736, 740 (1975), affd. without published opinion 523 F.2d 1053         
          (5th Cir. 1975).  Under California law, a person commits theft if           
          he "shall fraudulently appropriate property which has been                  
          entrusted to him, or * * * shall knowingly and designedly, by any           
          false or fraudulent representation or pretense, defraud any other           

               3    Petitioners did not contend, even in the alternative,             
          that their losses should be characterized as losses from a                  
          business or nonbusiness bad debt.  On the other hand, respondent            
          asserts, in her posttrial brief, that if petitioners sustained a            
          loss, it was a capital loss or a bad debt loss.  In this regard,            
          we are aware that a loss from a theft can generate a net                    
          operating loss carryback and carryover, whereas a loss from a               
          nonbusiness bad debt is treated as a short-term capital loss, and           
          its use for carryback and carryover purposes is restricted by               
          sec. 172(d)(4).  See United States v. Generes, 405 U.S. 93, 95-96           

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