Business ventures fail for countless reasons. Partners mismanage funds. Projects never materialize. Promises about how capital will be deployed go unfulfilled. When an investment goes south, the parties have to figure out how to minimize the damage. This often shifts the focus to how to benefit from the loss, which can warrant closer examination of how the loss is treated for tax purposes.
For losses incurred by a business rather than an individual, one option that might be claiming the loss resulted from theft rather than simple business failure. This can change the tax treatment. The timing is one aspect of it. A theft loss can be deductible in the year discovered, potentially providing immediate tax relief. An investment loss can often only be deducted in the year when the investment is disposed of or becomes completely worthless.
So is a business partner or operator’s misuse of funds theft or is it just a bad investment? Where does the law draw the line between a bad business deal and an actual theft that qualifies for a tax deduction?
The U.S. Tax Court recently addressed this question in Potts v. Commissioner, T.C. Memo. 2025-108. The case involves an investor who purchased shares in a business and whether he could claim a theft loss deduction when the sellers allegedly used the sale proceeds for personal purposes rather than completing a promised casino project.
Facts & Procedural History
Craig built a successful business providing cash management services to casinos across the United States and internationally. Through this work, he developed connections in the gaming industry that led to investment opportunities in the Turks and Caicos Islands. He and his spouse (the taxpayers) first invested there in 2001 by purchasing a beer distributor and later acquired a bar with slot machines.
Through these investments, Craig met Jack, who served as general manager of Carib Gaming, Ltd. Tatum and Rick controlled VT Enterprises, Ltd., which owned 75 of the 100 outstanding shares in Carib Gaming. Carib Gaming was an established slot machine operator in the Turks and Caicos, running 92 machines across 27 establishments. The company had recorded over $20 million in gross revenue in 2007.
In 2008, Tatum approached Craig with an investment opportunity. He described plans to build a casino in space leased from the Airport Hotel & Plaza. Carib Gaming had already begun renovations to the space, including excavating the floor to increase ceiling height. Tatum flew Craig and Olson to the Turks and Caicos to tour the property and discuss the casino project.
The parties entered into a Share Purchase Agreement in May 2008. Under this agreement, the taxpayers purchased 25 shares of Carib Gaming from VT Enterprises for $2,500,000. The taxpayers were represented by counsel who drafted the agreement. The agreement contained an integration clause stating it represented the only agreement among the parties and superseded all prior agreements whether written or oral. Importantly, the agreement did not specify how VT Enterprises would use the $2,500,000 in sale proceeds.
After the purchase, the taxpayers received benefits from their ownership. They received dividends from Carib Gaming on ten different occasions. On their personal financial statements for 2009 and 2010, they reported $500,000 and $200,000 of income from Carib Gaming respectively. Those same statements valued their Carib Gaming interest at $6 million.
The casino construction never progressed beyond partial demolition. The space remained in this partially demolished state for years. In 2014, Tatum allegedly sought to raise additional capital for Carib Gaming. During discussions with a potential investor, Tatum allegedly admitted to the taxpayers’ attorney that he had transferred $2 million of the 2008 investment to his and Olson’s personal bank accounts. According to this account, Tatum stated he needed additional capital to finish the casino project because of these transfers.
After learning of this alleged confession, the taxpayers negotiated to purchase VT Enterprises’ remaining shares in Carib Gaming for $225,000. As part of this 2014 transaction, the taxpayers released Tatum and Olson from all claims arising from Carib Gaming’s business operations. They never filed a civil suit against VT Enterprises or its principals.
On their 2014 federal income tax return, the taxpayers claimed a $2 million theft loss deduction under Section 165 of the Internal Revenue Code. The IRS audited the tax return and disallowed the deduction, assessed a deficiency of $431,691, and imposed penalties. The taxpayers petitioned the U.S. Tax Court to challenge these determinations.
The Foundation: What Qualifies as a Theft Loss Under Federal Tax Law?
Section 165(a) of the tax code provides a deduction for losses sustained during the taxable year that are not compensated by insurance or otherwise. For individuals, Section 165(c) limits this broad permission. The loss must fall into specific categories: losses incurred in a trade or business, losses incurred in a transaction entered into for profit, or losses arising from casualty or theft. Theft losses were essentially disallowed for individuals after 2017 and the Tax Cuts and Jobs Act. This case pre-dates that change.
The taxpayers claimed their loss fell under the theft category. To establish a theft loss deduction, a taxpayer must satisfy several requirements that distinguish true theft from other types of losses. First, the taxpayer must prove that a theft actually occurred under the law of the relevant jurisdiction. This is not a federal tax determination. The court looks to the criminal law of the jurisdiction where the alleged theft took place.
After establishing that a theft occurred under local criminal law, the taxpayer must prove the amount of the loss and the year in which it was sustained. For theft losses, the regulations provide that the loss is generally treated as sustained during the taxable year when the taxpayer discovers it. This discovery rule recognizes that victims often do not immediately realize they have been stolen from. There are also Madoff rules that provide some flexibility as to the year of the loss.
Setting aside the timing aspects of what year it is allowable, the threshold question for a theft loss is whether the alleged conduct actually constitutes theft as defined by the relevant criminal statute. Simply being treated unfairly or mading a poor investment might not be a theft. The conduct has to meet the specific statutory elements of a theft offense. This requirement prevents taxpayers from converting ordinary business or investment losses into more favorable theft loss deductions merely by characterizing disappointing results as criminal conduct.
Theft Under Turks and Caicos Law
Because the alleged theft occurred in the Turks and Caicos Islands, the U.S. Tax Court looked to the Turks and Caicos Theft Ordinance to determine whether a theft occurred. The Ordinance defines theft in language common to many jurisdictions: a person is guilty of theft if he dishonestly appropriates property belonging to another with the intention of permanently depriving the other of it.
The Ordinance creates a separate but related offense called theft by deception. This provision addresses situations where property is obtained through deception rather than simple taking. A person commits theft by deception if he by any deception dishonestly obtains property belonging to another with the intention of permanently depriving the other of it. The Ordinance defines deception as any deception—whether deliberate or reckless—by words or conduct as to fact or as to law, including deception as to the present intentions of the person using the deception.
Both theft and theft by deception require three core elements. First, there must be an appropriation of property belonging to another person. Second, the appropriation must occur through dishonesty or deception. Third, the person taking the property must intend to permanently deprive the owner of it. These elements work together to distinguish criminal theft from legitimate business transactions. These are very similar definitions that are used in U.S. law to define criminal theft.
The requirement that property belong to “another” is particularly important in commercial transactions and in this case. When parties enter into agreements for buying and selling assets, determining who owns property at any given moment requires examining the transaction’s structure and terms. Money paid as consideration for purchased assets typically becomes the property of the seller. The seller then owns that money and can use it however he chooses unless specific restrictions apply.
The element of dishonesty or deception similarly requires careful analysis in business dealings. Parties to commercial transactions regularly make representations about their plans and intentions. Not all failed promises or unmet expectations rise to the level of criminal deception. The law must distinguish between actionable fraud and the disappointments inherent in arms-length business relationships.
The Ownership Question: Whose Property Was Allegedly Stolen?
The tax court started with the first element of theft under the Turks and Caicos Ordinance: whether there was an appropriation of property belonging to another. This required the court to determine who owned the $2,500,000 after the 2008 transaction closed. The answer depended on how the transaction was structured.
The taxpayers did not invest capital directly into Carib Gaming. They did not contribute funds to the company in exchange for newly issued shares. Instead, they purchased existing shares from another shareholder—VT Enterprises, which was controlled by Tatum and Olson. This distinction decided this case.
When a buyer purchases existing shares from a selling shareholder, the purchase price becomes the property of the selling shareholder. This is a capital investment. The company whose shares are being sold has no claim to those funds unless the parties specifically agree otherwise. The sale represents a transaction between the buyer and the existing shareholder, not between the buyer and the company itself.
Neither the initial Memorandum of Understanding nor the formal Share Purchase Agreement required VT Enterprises to use the sale proceeds in any particular way. The agreements imposed no legal obligation on VT Enterprises to reinvest the proceeds into Carib Gaming or contribute them toward the casino project. The agreements created no restrictions whatsoever on how VT Enterprises could deploy the money it received.
The taxpayers never held an interest in VT Enterprises. They acquired no rights to control or direct how VT Enterprises used funds it received as consideration for selling its own assets. The $2,500,000 belonged entirely to VT Enterprises once the transaction closed. Tatum and Olson, as controllers of VT Enterprises, were free to use those funds however they chose as a matter of basic property law.
The taxpayers argued that the casino project was the primary purpose for their investment in Carib Gaming. Craig testified that Tatum orally promised the proceeds would be used to inject additional capital into Carib Gaming and complete the casino construction. Even assuming such oral promises were made, they did not change the legal ownership of the funds.
The Share Purchase Agreement contained an integration clause that proved fatal to the taxpayers’ position. The agreement specified it represented the only agreement among the parties and superseded all prior agreements whether written or oral. This provision barred the taxpayers from relying on oral promises that contradicted or supplemented the written agreement’s terms. Under basic contract law, the parties’ oral discussions before signing could not override the written agreement’s terms or create obligations the agreement did not contain.
The Deception Question: Broken Promises Versus Criminal Fraud
Even if the ownership issue could be resolved in the taxpayers’ favor, they still needed to prove the second element: that VT Enterprises obtained the funds through dishonesty or deception. The tax court has sustained theft loss deductions in cases involving false representations that induced taxpayers to part with property. However, these cases typically involve misrepresentations about existing facts that prove to be false.
The taxpayers offered no evidence that Tatum or VT Enterprises misrepresented any material fact about Carib Gaming’s condition as of the transaction date. They did not show Tatum provided false financial statements. They did not prove he lied about the company’s operations, assets, or liabilities. They did not establish he misled them about the status of gaming licenses or regulatory compliance. In short, they failed to identify any false statement about existing facts.
Instead, the taxpayers relied entirely on Tatum’s alleged promises about future conduct. According to their version of events, Tatum promised that in the future he would inject the sale proceeds into Carib Gaming and complete the casino project. This distinction between representations about present facts and promises about future conduct became the heart of the case.
The Turks and Caicos Theft Ordinance defines deception as deception by words or conduct as to fact or as to law. The definition includes deception as to the present intentions of the person using the deception. The taxpayers wanted the court to read this language broadly to encompass promises about future actions. The court declined to do so.
The taxpayers failed to establish this element here. They offered no evidence about Tatum’s intentions in 2008 when the transaction closed. They relied solely on Tatum’s alleged 2014 statements—six years after the initial investment—as recounted by their attorney. Even accepting these statements as true, they showed only that by 2014 the funds had been used differently than expected. They did not prove Tatum never intended to build the casino in 2008.
The taxpayers also failed to establish when the alleged transfers to personal bank accounts occurred. They wanted the court to infer the money was transferred immediately after the 2008 transaction. Nothing in the record supported this inference. The transfers could have occurred at any point during the six years between the initial investment and the alleged confession. Without evidence of timing, the taxpayers could not prove Tatum deceived them about his present intentions at the moment of the transaction.
Transaction Structure Matters for Theft Loss Claims
The court’s analysis shows why the structure of business transactions fundamentally affects theft loss claims. When investors contribute capital directly to a company in exchange for newly issued shares, the company receives and owns the contributed funds. If company insiders then misappropriate those funds, they steal property belonging to the company. The company—and potentially the shareholders as victims of the company’s loss—may have theft claims.
When investors purchase existing shares from current shareholders, the dynamic differs entirely. The purchase price goes to the selling shareholders as consideration for their personal property—the shares they owned. The company receives nothing from this transaction. If the selling shareholders use the proceeds for personal purposes, they use their own money. No theft occurs because they have not taken property belonging to another.
This distinction explains why the integration clause in the Share Purchase Agreement mattered so much. If the written agreement had required VT Enterprises to contribute the proceeds to Carib Gaming, the proceeds would have been held in trust for that purpose. Taking them for personal use would violate that obligation and potentially constitute theft. However, the agreement contained no such requirement. It did not restrict how VT Enterprises used the proceeds in any way.
The taxpayers’ reliance on oral promises could not overcome this structural reality. Contract law generally refuses to enforce oral agreements that contradict written contracts containing integration clauses. Tax law similarly will not recognize oral representations that would create criminal liability when the parties’ written agreement imposes no corresponding legal obligations.
The Takeaway
The line between a bad investment and a theft loss turns on whether the alleged conduct satisfies the elements of theft under applicable criminal law. Simply showing that funds were used differently than promised or expected is insufficient. The taxpayer must prove that property belonging to them was taken through criminal means as defined by the relevant jurisdiction’s theft statutes.
When investors purchase existing shares from other shareholders, the purchase price becomes the property of those selling shareholders absent specific contractual provisions to the contrary. Oral promises about how sellers will use the proceeds cannot override written agreements that create no such obligations. Without proving the sellers took property that legally belonged to someone else, investors cannot establish the first element of theft.
Promises about future conduct similarly cannot support theft claims without evidence the promisor never intended to honor them at the time they were made. Broken promises and disappointed expectations are inherent in business relationships. Not every unmet commitment constitutes criminal deception. Tax law requires proof of actual theft under criminal statutes before allowing the favorable tax treatment of theft loss deductions. Investors who want protection against misuse of funds must structure transactions with enforceable written restrictions on how proceeds will be deployed.
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