Losing crypto from exchange shutdowns, wallet hacks, scams, and other events are unfortunately 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 and is not black and white. Please speak to your own tax expert, CPA, or attorney on how you should treat taxation of digital currencies.
Note - 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. For more detailed information, please read our guide on how to deal with capital losses for your cryptocurrency.
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 that we see here at CryptoTrader.Tax are listed below:
Each scenario of cryptocurrency loss will fall under one of these three classifications: Casualty loss, theft loss, or investment (capital) loss. It is up to YOU how you want to handle and report your losses. The three categories are explained further below.
A casualty loss is damage, destruction, or property loss resulting from one of these identifiable events:
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:
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 cryptocurrency tax professional.
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:
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 with a unique situation. Our team is always happy to help refer you to someone.
It is not explicitly clear whether events like ICO scams or exchange shutdowns (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. As we discuss in our bitcoin capital losses guide, 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.
According to Alexander Leruth, Founder & CEO of Leruths and 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 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 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 writing 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.
Now that we have discussed the three different types of losses and how they can be applied in different cryptocurrency scenarios, we will now walk through the process of generating your crypto tax reports to include these losses appropriately within CryptoTrader.Tax.
If you want to classify your lost coins as non-deductible casualties, navigate to step 3 within the CryptoTrader.Tax web app. Here you should select the “Theft & Casualties” tab.
You should select the “type” to be a Casualty and then you can add a description to this casualty loss for your records. In the example above, the “Lost Wallet Access” description is selected.
These casualty losses will not be reflected on your 8949 after running your report. They will be displayed on the “Lost and Stolen Coins Report” and the dollar value of the amount of cryptocurrency lost will be detailed for your records. You do not need to do anything further with these losses as they are not deductible.
Remember, potential casualty losses could include lost private keys, exchange shutdowns, and other events. It is up to you how you want to classify your loss.
To report theft losses withi the app, again navigate to the Theft & Casualties tab in step 3. This time you should select “type” as Theft.
These theft losses will also not impact form 8949. They will appear on the “Lost and Stolen Coins Report” with the dollar value of the amount of stolen coins detailed for your records.
Finally, you can report your investment losses in a similar fashion. Again navigate to step 3, but select type “Investment Loss”.
This is the only type of loss that will affect form 8949 on your tax report. Remember as discussed above, investment losses will be deducted and reduce your gains on 8949. It is a gray area as to which scenarios qualify for this type of classification, so you should use your discretion and discuss with your tax professional.