Deductible Crypto Losses?

You’ve probably read about a cryptocurrency exchange called FTX, which recently suffered a very messy collapse, taking an estimated $32 billion of virtual currencies with it.  In other words, crypto investors are now roughly $32 billion poorer than they thought they were a couple of weeks ago, and this comes after a more than 70% drop in the value of their holdings purely due to market forces.  FTX founder/owner San Bankman-Fried allegedly used some of their assets to fund a hedge fund that specialized in trading within the crypto space—owned, interestingly enough, by Bankman-Fried himself.  The hedge fund made dodgy, highly-leveraged investments which, to put it mildly, didn’t pan out as hoped.

So can the people who lost all their holdings claim those losses on their tax returns?  Maybe.  Maybe not.  One of the interesting tax issues about crypto ‘investments’ is how they’re treated from a tax standpoint.  If you own Bitcoin or some other cryptocurrency, you would calculate gains and losses just like you would stocks or ETFs: once you sell, the amount above or below what you paid for it is a gain or loss.  Where it gets interesting is when you discover that somebody has hacked your account, or you lost the key to your cold storage wallet, threw away the hard drive that contained your wallet or otherwise no longer own these ‘assets.’  In those all-too-common cases, you can’t claim a loss on your tax return.

On the surface, then, it would appear that the FTX crypto losses would not be deductible, and the people who lost billions are out of luck.  But that may not be the last word.  Federal authorities who managed to retrieve Bankman-Fried from a hideout in the Bahamas plan to charge him with, among other things, running a Ponzi scheme—that is, an arrangement where he kept investor money and paid out some of it to maintain the illusion that people were earning returns on their ‘investments.’  The IRS regulations specifically state that victims of a Ponzi scheme can claim their losses.   

The whole FTX mess is yet another red flag about the world of cryptocurrency investing, as if we needed additional ones.  And for some, it’s a reminder that, whatever you think of crypto as securities, the IRS does expect their gains and losses to be reported on your tax forms.

Sources:

https://tokentax.co/blog/how-to-report-crypto-losses-on-your-taxes

https://finance.yahoo.com/news/where-did-money-ftx-crypto-230241698.html 

https://www.foxbusiness.com/financials/sam-bankman-fried-ftx-founder-charged-fraud-money-laundering