I claimed gambling losses and mortgage interest as itemized deductions, and the Department disallowed them for lack of proof -- what kind of documentation actually counts as proof of gambling losses?

Plain-English summary

A taxpayer claimed medical expenses, mortgage interest, charitable contributions, and gambling losses as itemized deductions on her 2020 and 2021 Virginia resident returns. During an audit, the Department asked her to substantiate those deductions; when she couldn't, the Department disallowed all of them, applied the standard deduction instead, and issued assessments for both years. She appealed, providing documentation specifically for her gambling losses and mortgage interest.

Gambling winnings and losses -- the basic rule. Gambling winnings are taxable gross income (IRC § 61(a)), and casinos must report slot-machine winnings of $1,200 or more on Form W-2G. Losses from gambling are deductible, but only as an itemized deduction and only up to the amount of reported winnings (IRC § 165(d)) -- you can't use gambling losses to create a net loss that offsets other income. The taxpayer had received W-2Gs for both years and reported the winnings; the dispute was over proving the losses.

What documentation actually counts. Casinos aren't required to track a gambler's losses or smaller winnings, so taxpayers have to substantiate losses another way. Following federal Tax Court precedent (Coleman v. Commissioner, citing Johnson v. Commissioner), acceptable proof includes casino ATM receipts, canceled checks payable to casinos, and credit card statements showing cash advanced at a casino. Here, the taxpayer's financial statements included both ATM withdrawals made at casinos and payments made directly to casinos -- both accepted as valid proof. But the statements also included ATM withdrawals from banks and other locations with no clear connection to a casino; without more specific identifying information tying those withdrawals to gambling, the Department couldn't allow them as proof of losses.

Mortgage interest -- a much lower bar. For mortgage interest (deductible under IRC § 163(a)), the taxpayer simply submitted a Form 1098 for each year, and the Department found that sufficient proof on its own -- no further documentation was required.

Outcome. The case was sent back to the auditor to recalculate the allowable itemized deductions using this framework -- allowing the clearly casino-connected withdrawals and payments as gambling-loss proof, excluding the ambiguous ones, and allowing the full mortgage interest shown on the Form 1098s -- with revised assessments to follow.

What this means for you

Anyone claiming a gambling-loss itemized deduction

Keep records that clearly tie withdrawals or payments to a specific casino -- ATM receipts printed at the casino, canceled checks made out to the casino, or credit card statements showing a cash advance at the casino. Generic bank ATM withdrawals, even if the cash was actually gambled, won't be accepted without something connecting them to a casino specifically.

Anyone claiming a mortgage interest itemized deduction

A Form 1098 from your lender is generally enough to substantiate the deduction on its own -- this is a far lower documentation bar than gambling losses.

Taxpayers who can't initially substantiate deductions during an audit

Losing itemized deductions at the audit stage (and being pushed to the standard deduction) doesn't necessarily end the matter -- providing the right documentation on appeal, as happened here, can get some or all of the deductions restored.

Common questions

Q: What proof do I need to deduct gambling losses?
A: Documentation that clearly ties a withdrawal or payment to a casino -- casino ATM receipts, canceled checks payable to a casino, or credit card statements showing a cash advance at a casino. Losses are also capped at the amount of your reported gambling winnings.

Q: Will a generic bank ATM withdrawal count as proof of a gambling loss?
A: Not without more -- if the withdrawal record doesn't clearly identify a casino, the Department won't accept it as substantiation, even if the cash was gambled.

Q: What do I need to prove mortgage interest paid?
A: A Form 1098 from your mortgage lender was accepted here as sufficient proof on its own.

Citations and references

Statutes and regulations:

• Va. Code § 58.1-301 -- Virginia's conformity to federal terminology/computation, starting from federal adjusted gross income
• Va. Code § 58.1-322.03 1 -- Virginia itemized deductions mirroring federal itemized deductions
• IRC § 61(a) -- gross income includes gambling winnings
• IRC § 165(d) -- gambling losses deductible only up to the amount of gambling winnings
• Treas. Reg. § 1.6041-10(b)(1) -- casino reporting of slot machine winnings of $1,200+ on Form W-2G
• Va. Code § 58.1-310 -- Department's authority to require federal return information in support of a Virginia audit
• Treas. Reg. § 1.6001-1(a) -- taxpayer recordkeeping sufficient to determine correct tax liability
• IRC § 163(a) -- deduction for mortgage interest on a principal residence

Cases cited: John M. Coleman v. Commissioner, T.C. Memo 2020-146; Johnson v. Commissioner, T.C. Memo 2007-373 (both on acceptable gambling-loss substantiation).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 24-20

Original ruling text

March 13, 2024

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will respond to your letter in which you seek correction of the individual income tax assessments issued to * (the “Taxpayer”) for the taxable years ended December 31, 2020 and 2021.

FACTS

The Taxpayer filed Virginia resident income tax returns for the 2020 and 2021 taxable years, claiming medical expenses, mortgage interest, charitable contributions, and gambling losses as itemized deductions reportable on federal Schedule A. Under audit, the Department requested documentation to support the deductions. When the Taxpayer indicated that she could not substantiate the deductions, the Department disallowed the itemized deductions. As a result, the Department applied the standard deduction and issued assessments for both taxable years. The Taxpayer appeals the assessments, contending that the documentation provided with the appeal substantiates her gambling losses and mortgage interest.

DETERMINATION

Conformity

Virginia Code § 58.1-301 provides, with certain exceptions, that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia . For individual income tax purposes, Virginia “conforms” to federal law, in that it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI). Income properly included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Chapter 3 of Title 58.1 of the Code of Virginia .

As a general rule, the Department relies on the accuracy of information and computations reflected on the federal income tax return when reviewing Virginia individual income tax returns. If the information provided on the federal return looks reasonable, there is generally no reason to look behind those computations.

Itemized Deductions

Virginia Code § 58.1-322.03 1 allows an individual to deduct from their Virginia adjusted gross income certain amounts allowed for itemized deductions for federal income tax purposes. A taxpayer may claim the Virginia standard deduction only if they have not elected to itemize deductions on her federal income tax return. These deductions include those for real estate taxes, home mortgage interest, personal property taxes, medical expenses, charitable contributions and gambling losses, provided they are claimed in accordance with the IRC and its related regulations.

Gambling Income and Losses

Pursuant to IRC § 61(a), gross income includes all income from whatever source derived, including gambling winnings. For a taxpayer that does not engage in gambling as a trade or business, losses from wagering transactions are allowable as an itemized deduction, but only to the extent of gambling winnings. See IRC § 165(d).

The Taxpayer played slot machines at several casinos during the 2020 and 2021 taxable years. Casinos are required to issue federal Form W-2G to report slot machine winnings of $1,200.00 or more. See Treas. Reg. § 1.6041-10(b)(1). Casinos, however, are not required to keep track of gambling losses or smaller winnings. See John M. Coleman v. Commissioner , TC memo 2020-146. Form W-2Gs were issued to the Taxpayer for both taxable years at issue. The Taxpayer reported these winnings as income on her federal and Virginia returns. She also reported gambling losses as an itemized deduction on Schedule A.

Substantiation

Taxpayers must maintain records sufficient to allow the Internal Revenue Service (IRS) to determine their correct tax liability. See Treas. Reg. § 1.6001-1(a). Similarly, Virginia Code § 58.1-310 provides:

Whenever in the opinion of the Department it is necessary to examine the federal income returns or any copy thereof of any individual, estate, trust, partnership or corporation in order properly to audit such returns, the Department or the commissioner of the revenue shall have the right to require such taxpayer to provide such return or a copy thereof and all statements, inventories, and schedules in support thereof.

Taxpayers have been able to substantiate gambling losses with such evidence as “casino ATM receipts, canceled checks made payable to casinos . . . and credit card statements stating that cash was advanced at the casinos.” See Coleman at 14, citing Johnson v. Commissioner , T.C. Memo 2007-373. In this case, it appears that the financial statements provided by the Taxpayer include some ATM withdrawals made at casinos and some payments made directly to casinos. The Department will allow a deduction for such withdrawals and payments. The statements provided, however, also include ATM withdrawals made at banks and other locations that are not clearly connected to a casino based on the descriptions given in the documents. Without more specific identifying information, the Department cannot allow a deduction for such withdrawals.

Mortgage Interest

IRC § 163(a) allows taxpayers to deduct mortgage interest paid on a principal residence. The Taxpayer submitted a Form 1098 for both the 2020 and 2021 taxable years. The Department finds that this form is sufficient proof to substantiate payment of deductible mortgage interest.

CONCLUSION

This case will be returned to the auditor to adjust the amount of allowable deductions consistent with this determination. The attached schedule shows the type of transactions with casinos that are acceptable proof of gambling losses. The Taxpayers will then receive revised assessments for the 2020 and 2021 taxable years.

The Code of Virginia sections cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/4625.B