One of the things needed for a casualty loss is certainty. There’s been relatively little of that when dealing with Absolute Poker (AP) and Ultimate Bet (UB) after Black Friday. While PokerStars quickly repaid players, and it appears players will eventually receive their money from Full Tilt Poker (those outside of the United States have already gotten their money), the status of AP/UB remains murky.

Let’s first run down the facts. Both entities shared a common gaming platform, Cereus. Cereus’ owner was (in theory) Bianca Games. After Black Friday, Bianca Games was negotiating with the US Department of Justice but unlike Full Tilt and PokerStars, Bianca Games had little money and not much in the way of other assets. At last report, the DOJ and AP/UB had agreed that AP/UB would forfeit its software to the DOJ, which would then auction it.

Even if the DOJ were to recover $100 million from that auction (and that’s a gross overstatement of the amount the software would likely fetch), there are many outstanding claims against that money. First, there’s the DOJ’s own civil complaint against Cereus. Then Bianca Games, the theoretical owner of Cereus, is pursuing some sort of bankruptcy. There are claims from foreign governments, such as Norway’s claim for 180 million Norwegian Kroner (approximately $30 million). The chance of players getting anything from Cereus (or the DOJ for Cereus) seems to be zero.

So we come to the crucial issue: Is the time ripe to claim a loss for funds on deposit with AP or UB? And if so, how is this done?

First, if you are an individual with funds on deposit with AP or UB, this is now the time to discuss this with your tax professional. It appears there is now certainty, something that is required to take a loss. Everyone’s situation is unique, so you will need to discuss this with your tax advisor to see if you can take the loss. Assuming you can take the loss, you will then need to discuss how you should take the loss.

The next question is, what kind of loss is it? The funds were on deposit with AP/UB, but does it qualify as a “Loss on Deposits?” The Tax Code specifies that such a ‘loss on deposits’ must be with a qualified financial institution (§165(l)(1)(A)). Unfortunately, §165(l)(3) further defines a financial institution to be a US-based entity. Thus, neither AP nor UB qualifies.

However, this does like a casualty loss. That’s defined as the damage, destruction or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. Black Friday would appear to be such a situation, and now that the loss appears certain a loss can be claimed.

But there are some flies in the ointment. First, let’s look at how casualty losses are deducted. Casualty losses are deductible in the year the loss occurs. So does this mean you may have to amend your 2011 tax return? Or should it be taken on the 2012 return? Or do we need to wait until 2013 or later?

There is administrative law on this subject. Section 1.165-1(d)(2)(i) of Treasury Regulations states,

If a casualty or other event occurs which may result in a loss and, in the year of such casualty or event, there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained, for purposes of section 165, until it can be ascertained with reasonable certainty whether or not such reimbursement will be received. Whether a reasonable prospect of recovery exists with respect to a claim for reimbursement of a loss is a question of fact to be determined upon an examination of all facts and circumstances….

Given the US government’s actions with Full Tilt, and the current situation of AP/UB/Cereus/Bianca Games, it appears that 2012 is the year to claim such a casualty loss. In 2011, the US government was taking action that looked like it could recover funds for individuals with money on these sites. Indeed, that appears to be the case for individuals with funds on Full Tilt. At least on the surface, that makes 2012 the year to claim a casualty loss.

But that does not mean impacted individuals will actually be able to take the loss. For amateur players, there’s no doubt you suffered a loss of money. Let’s consider a hypothetical taxpayer, Joe Gambler. He had $3,000 on deposit at Absolute Poker. He’s single and does itemize his deductions. In both 2011 and 2012 his Adjusted Gross Income (AGI) is $100,000. What casualty loss could he take?

For amateurs, a casualty loss is reported first on Form 4684 (Casualty Losses) and then on Schedule A (Itemized Deductions). All casualty losses are first reduced by $100 per §165(h)(1) of the Code. Next, a casualty loss is only allowed to the extent it exceeds 10% of the AGI. His AGI is $100,000, so 10% of that is $10,000. So we reduce his loss of $3,000 to $2,900 per the $100 reduction rule. Next, since $2,900 is less than $10,000 he’s not eligible to claim a tax loss. Mr. Gambler gets no tax benefit. An amateur gambler would need a low AGI and/or a high loss from AP/UB to obtain a tax benefit.

Professional gamblers are treated differently. When a business suffers a casualty loss, neither the $100 threshold nor the 10% AGI reduction apply. Thus, a professional gambler gets the benefit of the loss.

The loss would flow from Form 4684 (Casualty Losses) to Form 4797 (Sales of Business Property) and then to Form 1040. Such a loss can result in a Net Operating Loss. However, it does not lower business income and it does not impact self-employment tax.

There are two final issues to discuss. First, casualty losses are a high audit risk area. Your return will likely be scrutinized, so you need to be able to prove your loss. Do you have the records to show the loss? Again, this is something for you to discuss with your tax professional.

Second, the regulations within §1.165-1 look more toward thefts, disasters, and similar casualty losses than a situation like Absolute Poker/Ultimate Bet. While it does appear that a casualty loss does apply, you and your tax professional will need to discuss your entire situation and the facts and circumstances around your funds on AP and UB to decide whether you should take a casualty loss.

Finally, remember that any money you “won” in 2011 that you never received is not eligible for taking a casualty loss (unless you declared it as income). Since you never “won” that money (it never appeared on your tax return), you suffered no tax harm and there is no tax loss.

CIRCULAR 230 NOTICE: As a reminder, this opinion is limited to the one or more Federal tax issues addressed in the opinion. Additional issues may exist that could affect the Federal tax treatment of the transaction or matter that is the subject of this opinion and the opinion does not consider or provide a conclusion with respect to any additional issues. With respect to any significant Federal tax issues outside the limited scope of this opinion, the article was not written, and cannot be used by the taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.