Are Stolen, Lost & Hacked Cryptocurrencies Taxed? Learn How.
02 December 2022taxes
Summary : 2022 has been an eventful year for crypto theft, fraud, and lost or hacked coins. Since the collapse of Celsius and Voyager, there have been recorded numbers of crypto investors who have either been exposed to fraud or had their coins locked up by an insolvent lender or exchange. Are you a crypto holder who has been scammed out of your digital assets? If so, you may be wondering how to report the theft on your taxes. Some losses are deductible, so read on to learn more about how to report stolen crypto on your taxes.
In this blog:
- Scenarios of money lost through cryptos
- Can lost cryptocurrencies be written off?
- Can stolen cryptocurrencies be written off?
- Can investment lost be written off?
- How are taxes levied on rug pulls?
- Reporting losses on crypto projects or NFT mints scams
- Reporting losses due to exchange shutdown
- Can you claim lost/stolen crypto as a capital loss?
- Reporting stolen/lost cryptos in the US
- Safeguarding against Losses
Exchange closures, wallet breaches, frauds, and other issues are unfortunately frequent in the world of cryptocurrency and NFTs today. However, depending on the circumstances, how these events are taxed may vary. This guide provides an overview of the most common types of theft and crypto losses and discusses how they may be treated from a tax perspective in the United States.
Losing crypto to hackers, criminals, and exchanges going out of business is all too common in the cryptocurrency world - but what does it imply for your taxes? Learn how to report stolen or lost cryptocurrency so you can claim a loss.
Crypto investors are unfortunately all too familiar with hackers and scammers. For example, in 2018 there was the Coincheck hack, followed by KuCoin in 2021, and then Poly Network later that same year. In fact, the FBI has stated that over $1 billion dollars were stolen from Ethereum alone in just the first quarter of 2022.
Many people have lost their crypto due to common blunders like misplaced private keys, sending crypto to the incorrect address, or breaking or losing cold storage devices.
Whatever the cause, if you can't get your crypto back, you may be wondering what this means for your taxes. Is it possible to claim it as a loss? Do you have to report it?
If your cryptocurrency's price falls and you decide to sell it, this is a capital loss from investment of capital Assets. This is not the same as some of the losses we'll address below. Please read our article on how to manage capital losses for your cryptocurrency for additional information.
If user will report a loss in 2022 and receive funds in 2024 or later then that funds received will be taxable income in the same year i.e. 2024
Various situations where you could lose money through cryptocurrency
Different circumstances are subject to varying legislation when it comes to deducting or reporting cryptocurrency losses. The following are the most frequent forms of cryptocurrency losses that most individuals encounter:
- Casualty Loss: (e.g. Lost access to Wallet, Sent crypto to an incorrect address)
- Theft Loss: (e.g. Someone hacked the exchange or wallet, coins got stolen)
- Investment Loss: (This is the gray area; e.g. Closure of an exchange or ICO Scam)
The aforementioned are three categories that your cryptocurrency losses can fall into.
Can lost cryptocurrencies be written off?
A casualty loss is any resulting damage, destruction, or property loss from one of the following identifiable events
- Sudden event — swift, quick; not progressive or gradual
- Unexpected event — unplanned, unintentional, unexpected
- Unusual event — a rare occurrence
Following the Tax Cuts and Jobs Act's passage in December 2017, numerous forms of casualty losses that were formerly deductible on Form 4684 no longer qualify as a deduction. According to the IRS site, you can only claim a deduction for lost or stolen if there has been a Federally declared disaster by the President of the United States.
In the case of cryptocurrencies, whenever you lose them due to carelessness or negligence, it is a loss that is not deductible for tax purposes.
The following are not examples of casualties that you would receive a tax break for:
- When people lose access to their private keys and wallets, the coins stored in them are lost as well.
- If you accidentally send your coins to the wrong address, they will be lost and unable to be recovered
- There are several types of crypto loss that caused due to negligence
If any of the following apply to you, then you are not allowed to claim a capital gain or loss on your cryptocurrency.
Can stolen cryptocurrencies be written off?
Theft is the unlawful taking and removal of money or property from someone with the goal of depriving them of it. It must be illegal under the state law in which it took place, as well as have a criminal purpose.
Some common ways people have their cryptocurrency stolen are as follows:
- Wallets that are hacked
- Coins that are stolen
- Exchange accounts that are hacked
Theft lost are no longer deductible on Form 4684, as they were in the past, after the Tax Cuts and Jobs Act was introduced. If your cryptocurrency is stolen and the IRS views it as a theft, you most likely will not be able to deduct it from your taxes. However, you can read more about these possible restrictions on the IRS website.
The only way you can receive a tax exemption for your lost crypto is by reporting it as an investment lost. It's also worth noting that the IRS doesn't define exactly what constitutes a cryptocurrency loss and neither clarifies which crypto loss scenarios are eligible for investment lost status. We recommend consulting a tax professional about your specific circumstances.
Can investment lost be written off?
We are still in the dark about whether something like an ICO scam can be classified as an investment lost. We asked numerous tax professionals with experience in cryptocurrency, and they could not come to a consensus.
If you sell stocks or other assets for less than the original purchase price, this causes a Capital loss on Investment of assets. The same goes for selling cryptocurrency.
If you have a capital loss of $50,000 or more on an asset you bought, it's reportable to the IRS on Form 8949 and must be reported as follows: The cost basis in the property, the fair market value at the time you sold it, and the net gain or loss.
Up to $3,000 of net capital losses can be deducted in any given year. Larger losses will be carried forward to future years. This is the basic mechanism for reporting most cryptocurrency transactions.
There is no black-and-white guidance from the IRS on how to classify and report these events. As a result, you must make your own judgments in these cases. We'll go through them below.
How are taxes levied on rug pulls?
Unfortunately, quite a few cryptocurrency and NFT investors have been taken advantage of by rug pull scams. In these schemes, promoters entice potential investors with the promise of high returns, only to take the money and run, leaving them holding worthless assets.
If there is no market for your rug-pulled asset, you might be able to declare an unrealized loss in particular cases (for example, the asset has no trading volume on exchanges). In this scenario, expecting a return of capital on your investment would not be realistic.
If an asset has liquidity and is still being traded on exchanges, you won't be able to claim a loss until you sell it. Even if your assets have dropped in value since you received them, this is the case.
How to report losses on crypto projects or NFT mints scams?
Fraudulent or non-existent crypto tokens and NFTs may mean that investors lose money. Tax experts have various views on how to handle these losses on tax returns.
The solution is to treat it as stolen, which is a personal loss that does not qualify for 8949. You might attempt to claim it on 8949 and argue that the investment's value had been effectively depleted at a $0 cost, but this is a hazardous strategy to take.
However, few tax experts believe that such projects should be treated as capital investments. Therefore, a scam would be considered a capital loss on 8949. If this happens, it is advisable to get a report from the local police, FBI, Financial Crimes divisions, or SEC noting that you have reported this investment as fraudulent and explain the situation. This documentation will protect you during an IRS audit.
There were many different viewpoints on the best way to handle these schemes.
However, any money lost as a result of a crypto/NFT fraud can be claimed as an investment loss on 8949 Form.
If, for example, you put $6,000 into an ICO that turned out to be fraudulent and received 20,000 XYZ tokens in return for what was represented to be a $6,000 investment with a $0 profit and a $6,000 loss on your 8949s due to the sell entry with a cost basis of $6,000 and proceeds of $0.
If user will report a loss in 2022 and receive funds in 2024 or later then that funds received will be taxable income in the same year i.e. 2024
How do you report losses due to a shutdown of an exchange?
Exchange closures like those of Cryptopia and Mt. Gox are in a murky legal area.
Some experts argue that these would be an investment lost that can be listed on Schedule 8949, and so you may claim a Capital Loss, while others believe a Cryptocurrency exchange shutdown would be a non-deductible personal catastrophe.
The shutdown of an exchange is a better fit on 4684 [which is Casualty Loss], but no one wants to hear that because the majority of 4684 has been erased since the Tax Cuts and Jobs Act. There's a compelling argument for why it might be an investment lost as Capital loss, but it's a dangerous place to take it.
Can you claim lost/stolen crypto as a capital loss?
If you are an investor, then you most likely know that you have to declare your crypto gains and losses as well as any money made from crypto. Also, Capital Gains Tax will affect your cryptos no matter where in the world you reside.
In many countries, you can deduct your net capital losses against your net capital gains. This lowers your overall tax burden, so you'll pay less in taxes. In fact, most nations allow you to carry forward losses from one year to the next if you've already offset the maximum amount of allowable net capital loss for that year.
Investors can offset net capital losses against net capital gains to reduce the overall tax bill
So, the most important question we'll address in this article is: Is lost or stolen crypto treated as a capital loss?
The answer to this question varies depending on your location.
Tax authorities in various countries take a variety of approaches to this problem. We'll look at how the US handles lost and stolen cryptocurrencies from a tax perspective.
Reporting stolen/lost cryptos in the US
According to the IRS, capital gains can be divided into two categories, a) casualty losses, and b) theft losses.
In the event of a casualty loss, you would have sent crypto to the incorrect wallet or lost your wallet. On the other hand, a theft loss is when your exchanges are hacked or cryptocurrency is stolen from your wallets
According to IRS guidance, casualty losses were deductible as a loss before the Tax Cuts and Jobs Act of 2017. Now, the only way a casualty loss can be tax deductible is if it's a Federally declared disaster by the President of the United States - which probably won't affect your crypto!
- misplaced your private keys,
- sent your assets to the incorrect address, or
- lost them due to carelessness,
you can't deduct this as a capital loss.
Theft losses were also tax deductible in the past. Thefts, on the other hand, have been affected by recent changes to the tax code. They are no longer deductible due to these revisions in the tax code.
If you've lost crypto due to a hack or fraud, you can't declare it as a loss and offset it against your profits. The IRS actually says that the thief must disclose the market value of the stolen assets on their tax return!
So, if you lose your crypto through carelessness or to a scammer, the best thing for you to do is write it off and forget about it entirely.
Lost/Stolen Crypto in the USAThe IRS is clear about rules for stolen/lost cryptos. In both instances, they cannot be claimed as capital losses.
Safeguard Against Losses
You can take several measures to avoid losing your cryptocurrencies, and thus preventing painful tax deductions. These steps include:
Insured Exchanges - To safeguarded your finances, only use crypto exchanges that insure against hack-related losses and protects your funds even during security breach.
Crypto Insurance - Protect your precious cryptocurrency from theft by purchasing crypto insurance. For example, if a hacker manages to steal digital currency from your account, CoinCover will reimburse you with an insurance policy of up to $100,000.
Cold Storage - investments for the future are best kept out of reach from hackers by storing them in cold storage. But, like anything else you want to keep safe
Due Diligence - Before investing in any crypto opportunity, do your research by reading the whitepaper and looking for red flags. For example, see if there are reputable investors backing the project. Also, beware of anyone trying to pressure you into a purchase without letting you investigate first.
Diversification - By investing in multiple cryptocurrencies, you can protect your entire portfolio from the negative impacts of a single security incident. For example, investors staking crypto may choose to invest in multiple DeFi networks rather than just one.
Investors may also want to consider using ETFs or other investment vehicles that don't involve direct cryptocurrency ownership. Larger investors can also use derivatives to shield themselves against market fluctuations and financial crime.
- Because of the intricacies of cryptography, many people lose their money through hackers, con men, and even misplacing their private keys.
- If you have lost or stolen cryptocurrency, you may be able to claim it as a capital loss on your taxes, depending on the tax office.
- You can't deduct a capital loss for crypto that has been lost or stolen.
- The HMRC allows you to make a minor value claim for lost and stolen crypto
- The ATO allows you to claim a capital loss on cryptocurrency that has been lost or stolen, but you'll need evidence.
- The CRA has no clear position on whether a cryptocurrency that has been lost or stolen can be utilized as a capital loss.
the IRS ruled that an exchange shutdown is a non-deductible event, which means it isn't deductible. This is definitely the more cautious approach from a tax standpoint. However, there was no unanimity among experts.
The Tax Cuts and Jobs Act of 2017 does not allow for casualty or theft losses to be deducted, but if you've been defrauded, you might be able to deduct your cryptocurrency losses as investment losses. Even though some of these types of losses aren't tax-deductible, it's still important to tell your accountant about them or input the information into your crypto tax software so that your taxes will be prepared correctly.
Even if you can use certain deductions, they won't even begin to compensate for the overall losses. As a result, it's critical to do all possible to avoid these sorts of expenses in the first place by employing insurance plans, sound due diligence, cold storage, diversification, and other similar methods.
CRPTM can help cryptocurrency traders ensure they maximize their tax deductions and accurately report their tax liabilities. Our platform combines all of your transactions, calculates your capital gains and losses, and auto-fills the forms you need by automating the process.
CRPTM Disclaimer: Please note that the following information is solely for educational purposes and should not be taken as tax, legal, or investment advice. The cryptocurrency taxation landscape is always changing and there's no easy answer. Be sure to speak with your own tax specialist, CPA, or lawyer to learn how digital currencies should be taxed in your situation.
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