No one likes losing their hard-earned money or investments. Unfortunately, quite many cryptocurrency investors have experienced being a victim of either theft, a scam, or lost access to their cryptocurrency in a different way. When it comes to tax reporting, the current regulations surrounding lost or stolen crypto assets are somewhat complicated with many nuances.
This article will explain and break down everything you need to know about how such events should be treated for tax purposes from a US citizen’s perspective.
Scenarios for Lost/Stolen Crypto
There are several different ways you might experience losing (access to) your cryptocurrency holdings. Because the current tax rules in the US are different for various scenarios, we need to look at each specific case more in detail to understand the implications better.
The most common scenarios for losing access to your crypto assets that will be discussed in this article are:
- Losing access to your own wallet
- Wallet or exchange account hacks
- Exchange shutdowns
- ICO scams
Each of these scenarios will be discussed in more detail below.
Lost Wallet Access
How you are securing your cryptocurrency is even more important today than ever before, and it’s always best practice to keep a backup of your private keys in case you would lose access to your wallet. If you have actually lost your private keys, there are unfortunately very few ways to recover access again.
Losing access to your wallet can in most cases be classified as a casualty loss, which the IRS defines as the following:
A casualty loss can result from the damage, destruction, or loss of your property from any sudden, unexpected, or unusual event (…)– The IRS
From a tax perspective, you were allowed to claim tax deductions for such casualty losses in the past, but this changed after the passing of the Tax Cuts and Jobs Act in late 2017. As discussed in Topic No. 515, you are now only allowed to claim deductions if “the loss is caused by a federally declared disaster declared by the President”.
This means that you are not allowed to claim a tax deduction for losing your cryptocurrency due to missing private keys, or if you somehow else have lost access to your wallet.
Wallet or Exchange Hacks
There have been several instances of large exchange hacks since the first crypto exchanges were established several years ago. Even though exchanges are going to great lengths to secure their platform, it is likely to also happen again in the future.
The IRS defines a theft loss as the following:
A theft is the taking and removal of money or property with the intent to deprive the owner of it. The taking must be illegal under the law of the state where it occurred and must have been done with criminal intent.– The IRS
Both wallet and exchange hacks can be classified as theft losses, and similarly to casualty losses discussed above, you are no longer allowed a tax exemption for such cases after the passing of the Tax Cuts and Jobs Act in 2017. For more information about the current tax rules, see Publication 547: Casualties, Disasters, and Thefts from 2019.
There have been several unexpected and sudden exchange shutdowns in the cryptocurrency world in the last couple of years, where maybe two of the most well-known events were the Cryptopia and QuadrigaCX shutdown. This resulted in thousands of customers losing all their funds held on these exchanges, and may now wonder if they are allowed a tax exemption or not.
From a tax perspective, it’s not clear whether a loss resulting from an exchange shutdown should be classified as a casualty loss (discussed above), or as an investment loss. There is no clear guidance on this matter issued by the IRS, and even tax professionals have very different opinions as to whether such losses should be considered capital losses or not.
If the loss is considered to be a casualty loss, then you are not allowed any tax exemptions. However, if you consider the exchange shutdown to result in an investment loss, it can be treated as a capital loss and should be reported on Form 8949.
Let’s assume that you held 2 bitcoin (BTC) on QuadrigaCX at the time when the exchange was shut down. You paid $8,000 initially for acquiring these coins, hence you would have a realized capital loss of $8,000 if you consider the loss to be an investment loss.
We recommend talking to a tax professional first if you have lost any cryptocurrency from an exchange shutdown, and you want to report this as an investment loss.
Similarly to exchange shutdowns discussed above, whether or not you are allowed a tax deduction from an ICO scam depends on if it’s classified as a casualty or investment loss. There is no clear guidance on this matter either, so it’s probably wise to discuss each specific case with a tax professional before reporting it as an investment loss if you plan to do so.
As an example, let’s assume you have invested $3,000 in an ICO for the token XYZ. The ICO turned out to be a fraudulent scam and you never received any tokens when you were supposed to. If this was to be classified as an investment loss, you would report this as a sale with a cost basis equal to $3,000, total proceeds of $0, and a capital loss of $3,000.
The conclusion from this guide should be that there is currently no clear guidance on how to treat lost or stolen cryptocurrency for tax purposes. If the loss is to be considered a casualty or theft loss, you are not allowed any tax exemptions in the US. However, if the loss is considered an investment loss, which can potentially be the case of an exchange shutdown or ICO scam, you can report this as a capital loss and are therefore allowed a tax exemption.
The important takeaway is that you should always talk to a tax professional before reporting any lost or stolen cryptocurrency as an investment loss if you want to be on the safe side.
If you have bought or sold cryptocurrencies, it’s very important to keep track of all transactions and report your taxes correctly to avoid any penalties from the IRS or other tax authorities. A cryptocurrency tax solution like Coinpanda makes it very easy to report your taxes, and you can easily account for any lost or stolen crypto by simply tagging the transactions in the software.
If you want to learn more about how cryptocurrencies such as bitcoin are taxed, please refer to our in-depth tax guide that is regularly updated: