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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
(1972).
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