The general rule is that you can deduct losses because of fraud and theft, including identity theft, though there are certain limitations. You can also deduct losses because of casualty events such as hurricanes, floods, fires and earthquakes, as well as gambling losses, to the extent of your gambling winnings.
Identity Theft Background
Identity theft is a crime, and one that has become a big problem for American consumers. The Federal Trade Commission -- the federal agency that has the primary responsibility for tracking identity theft -- estimates that identity theft strikes as many as 9 million Americans each year. Common schemes include obtaining credit cards and opening cellphone accounts in the victim's name, stealing checkbooks or credit cards out of mailboxes, and mail order fraud.
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Insurance and Deductibility
You can only deduct losses because of identity theft to the extent you are not reimbursed or compensated for the loss. If you have received a payment from a private insurance company or if you have been reimbursed by a bank or other institution for moneys stolen from your account, you cannot take a deduction for that amount.
To claim the deduction, file IRS Form 4684, Casualties and Thefts. The form is divided into two parts: Part A is for personal losses, while Part B is for business losses. If the thieves stole your business identity, you may have to fill out Part B. Return the form along with your income tax return for the year.
Since you are taking a tax deduction for your identity theft loss, you must keep records to document your deduction, in case the IRS selects you for an audit. Normally, you should keep these records for at least three years after filing your return. This is the amount of time the IRS has to challenge your deduction. Keep a copy of your police report, and all correspondence relating to the theft. You should be able to prove the amount of the fraud and the dates from your records if you are audited.