By Unfortunately, losing crypto from exchange shutdowns, wallet hacks, scams, and other events is common in the world of cryptocurrency today. From a tax perspective, these events are not all treated the same, and it largely depends on the specifics of the circumstances. This guide walks through the most common forms of theft and crypto losses and the possible ways to treat them from a tax perspective in the U.S.
Disclaimer: This post is for informational purposes only and should not be construed as tax, legal, or investment advice. The area of cryptocurrency taxation is constantly evolving. Please speak to your own tax expert, CPA, or attorney on how you should treat taxation of digital currencies.
If your cryptocurrency simply went down in price prior to selling it, this is considered a capital loss or an investment loss. This is different than some of the losses we discuss below relating to cryptocurrency taxes.
Cryptocurrency Losses Scenarios
When it comes to deducting or filing cryptocurrency losses, different situations apply to different tax rules within the U.S. The most common forms of cryptocurrency losses are listed below:
- Lost Wallet Access (Casualty, Non-Deductible)
- Sent to Wrong Address (Casualty, Non-Deductible)
- Exchange Account Hacked/Wallet Hacked (Theft)
- Stolen Coins (Theft)
- ICO Scam (Gray area)
- Exchange Shutdown (Gray area)
Different forms of losses trigger different tax treatments: Casualty loss, theft loss, or investment (capital) loss. These categories are explained further below.
Casualty Losses
A casualty loss is damage, destruction, or property loss resulting from one of these identifiable events:
- Sudden event — swift, rather than gradual or progressive
- Unexpected event — ordinarily unanticipated and unintended
- Unusual event — not a day-to-day occurrence
Post 2017, after the Tax Cuts and Jobs Act was passed into law, many forms of casualty losses that were previously deductible on form 4684, no longer qualify for deductions. As seen on the IRS site here, the only property that can be claimed as a deductible casualty has to be a federally declared disaster.
In the case of cryptocurrency, anytime you negligently lose your cryptocurrency, it would be a casualty that is not deductible for tax purposes.
Examples of casualties that you would not receive a tax break include the following:
- Coins lost from lost access to private keys & wallets
- Coins lost from sending to incorrect addresses
- Other negligent forms of crypto loss
If you think you might have a unique case, or if you have questions on a casualty loss in general, it’s always a good idea to discuss with a qualified crypto tax professional.
Theft Losses
A theft is the taking and removing of money or property with the intent to deprive the owner of it. The taking of property must be illegal under the law of the state where it occurred and done with criminal intent.
Common cryptocurrency theft losses include the following:
- Stolen Coins
- Hacked Wallets
- Hacked Exchange Accounts
Similar to casualty losses above, post-2017 after the Tax Cuts and Jobs Act was passed, theft losses are no longer deductible on Form 4684. If your cryptocurrency was stolen and classifies as a theft loss, it’s unlikely that you can write this off. You can read more about the details of these rules in the IRS guidance here.
Reporting your lost crypto as an investment loss is the only approach that allows a tax exemption. As you will read below, it is unclear which crypto loss scenarios qualify for the investment loss status. We recommend consulting a tax professional that specializes in bitcoin tax treatment with a unique situation.
Investment Losses (Capital Loss)
It is not explicitly clear whether events like an ICO scam or an exchange shutdown (like Mt. Gox) can be treated as an investment loss. We surveyed many tax professionals familiar with cryptocurrency when writing this article, and they do not all agree on the proper treatment.
Investment losses are similar to a loss you would incur from buying a stock or another form of property and then selling it for less than you acquired it for. The same applies to selling bitcoin for less than you acquired it for.
This type of capital loss is reportable on form 8949 where you must list your cost basis in the property, the fair market value at the time you disposed of it, and the net gain or loss. Remember, up to $3,000 of net capital losses are deductible in any given year. Larger losses will carry forward to future tax years. This is the basic process for reporting the majority of cryptocurrency transactions.
No black and white guidance from the IRS exists for these specific scenarios, so ultimately you must use your discretion on how to classify and file these events. We will walk through the different options below.
ICO Scam
According to Alexander Leruth, CFO of Ahrvo, “The correct method would be treating it as stolen which is a personal casualty loss that wouldn’t qualify for 8949.” Leruth goes on to explain, “you could try to claim it on 8949 and say that the value of the investment was essentially done at a $0 cost, but that’s a risky position to take.”
On the other hand, Pasha Malik, Co-Founder and President of Thyor Advisory Group (a tax compliance firm), argues that one should “use SEC guidance unless otherwise mentioned. In general, treat ICO as a securities offering and investing in it would be a capital investment. So a scam would be a capital loss on 8949. In such a case it is often recommended to obtain a report from FBI, local police or SEC or Financial crimes divisions that you have reported this investment as a fraud and scam. The report is for your own IRS audit protection.”
We surveyed many tax professionals when writing this piece, and there were many differing opinions on the proper treatment of ICO scams.
Ultimately, claiming an ICO scam as an investment loss will deduct the amount invested on form 8949.
For example, if I invested $5,000 in exchange for what I was told would be 20,000 tokens of XYZ in an ICO which turned out to be fraudulent, then my 8949 would include a sell entry with a $5,000 cost basis, a $0 proceeds, and a $5,000 loss.
Exchange Shutdown
Exchange shutdowns like that of Cryptopia and Mt. Gox come with similar gray area as fraudulent ICO’s.
Some professionals argue that these would be an investment loss that can be reported on 8949, and therefore you can receive a tax break, while others claim an exchange shutdown would be a non-deductible personal casualty loss.
Matt Metras, an enrolled agent and cryptocurrency taxation specialist at MDM Financial Services, says that an exchange shutdown is “definitely a better fit on 4684 [Casualty Loss], however no one wants to hear that as 4684 is mostly gone post-Tax Cuts and Jobs Act.” Matt also goes onto say that “there is a nuanced argument for why it could be an investment loss, but that it’s a risky position to take.”
In our survey for this article, most tax professionals saw an exchange shutdown as a casualty loss, and thus not a deductible event. This is certainly the more conservative approach to take from a tax perspective. However, there was not complete consensus amongst professionals.
It has been noted that the IRS is investigating more crypto tax cases. Make sure you are aware of the treatment of cryptocurrency in your jurisdiction.
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