A reasonable prospect of recovery exists when a person who has suffered a loss holds a claim for reimbursement that has a realistic chance of being paid: an insurance claim, a bankruptcy or receivership claim, a lawsuit or a restitution order. The test is objective and looks at the facts as they stand, not at whether recovery is certain.
After a hack or scam, several routes to getting something back often open at once. The exchange may announce it will reimburse customers. A receiver or bankruptcy trustee may be appointed over a fraudulent platform. Law enforcement may seize wallets and start a restitution process. A class action may be filed against a third party. Each of these is a claim for reimbursement, and while any of them has a realistic chance of paying, the loss is not yet final.
The prospect changes over time. A claim that looked strong when the receiver was appointed may be worth cents on the dollar once the asset schedule is published, and a claim that looked hopeless may pay out when seized coins are distributed years later. What matters for tax is the position at the end of each year.
It delays the deduction, and it can split it across years. Under Treasury Regulations section 1.165-1(d), a loss is deductible only for the year in which it is sustained, and where a claim for reimbursement exists with a reasonable prospect of recovery, the portion of the loss that the claim may cover is not treated as sustained until the year in which it can be ascertained with reasonable certainty whether reimbursement will be received. Treasury Regulations section 1.165-8 applies the same principle to theft losses specifically: the loss is sustained in the discovery year, unless a reimbursement claim with a reasonable prospect of recovery exists in that year, in which case that part waits.
Whether the prospect is reasonable is a question of fact decided on all the circumstances. It does not require certainty, and it does not depend on the taxpayer's own optimism. A registered bankruptcy claim against a platform holding identifiable assets is a reasonable prospect. A police report about a wallet drained to a mixer, with no identified suspect and no seized funds, generally is not.
The rule works in both directions. If the claim is later settled for less than the amount held back, the shortfall is deductible in the year that becomes certain. If a loss was deducted and a recovery arrives later, the recovery is included in gross income in the year received rather than by amending the earlier return. This is why a crypto theft loss is often reported in pieces: the unrecoverable part in the discovery year, the rest when the claim resolves. The Ponzi scheme safe harbor exists partly to avoid this analysis, replacing it with fixed percentages and a defined third-party recovery claim rule.
The common failure is deducting the full loss in the discovery year while a bankruptcy or receivership claim is still live. The deduction is overstated for that year, and when a distribution arrives two or three years later it has to be brought into income, usually after the taxpayer has forgotten the deduction was taken. The claim filing, the receiver's reports and the distribution notices need to be kept with the return for every year the claim is open, so that the held-back amount and the eventual income are both traceable.
Read our 2026 Guide to Claiming Crypto Losses from Fraud, Scams, Theft
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