When do I take a loss on a defaulted loan?

It sounds strange. The company could have sold the gems and got $200,000 cash and wouldn't have to deal with you.

Anyway it looks like you bought gems for 200k. Whether the money was going to a company to fund their operations is irrelevant. So you have a capital loss on your investment as you sell the gems.

I'm sure they're worth more than zero though.

In case this was really a scam, and you can show that, you might be able to claim a casualty/theft loss. For example, if you bring the facts to your local prosecuor and he agrees and pursues an indictment, that might do it.

That's a good point. Another thread points out that casualty losses are allowed for NOL, which means that if the casualty loss (which is the excess of the 200k loss over 10% of your AGI, minus $500) is more than your AGI then you can deduct a subset of the loss to get your taxable income to zero, and carry forward the rest. Then again, if the original filers income is like $2,000,000 then the casualty loss approach is worthless as the 10% + $500 rule means that only the loss above $200,500 is deductible.

No scam, at least not one I have been able to figure out. I had a jeweler I know appraise the gems before the loan, and they covered it even after marking the labradorite down to zero. In 2001 (this goes way back) the market for colored gems crashed and hasn't come back.

He did not want to sell the gems because it was too long a process to sell them at a decent price; no one will pay a good price for them unless they have an immediate use for them. So I have the jeweler selling them for me, but at this rate it might take another 10 years.

So... I do nothing until I sell the last gem; then I have a loss for the loan minus sales. Right?

You take the loss as you sell as gems. So if in 2011 you sell 2 pounds of the total 20 pounds for $500 including selling fees, you have a cost basis of 2/20*200k k, thus loss of $19,500. It's no different than selling small batches of your large holdings in stock ??? over the years.