Did you get rug pulled or lost your crypto? Is there a way to offset some of the losses from a tax perspective?
Unfortunately, there are still many projects in crypto which are “pump and dump” schemes. Newly launched tokens serve as quick cash grabs while defrauding early investors. You can also be a victim of an exchange attack and have your funds stolen. On top of that, you can lose access to your private keys, have a “boating accident,” or lose your crypto.
Is there a way to recover some of these losses from a tax perspective? Today, we explore the tax implications (including reporting) on stolen, lost, and scammed crypto.
Do I have to pay tax on stolen or hacked crypto?
Since the Mt. Gox hack, many exchanges have suffered attacks from hackers, stealing billions in funds throughout the years. If you hold your crypto in hot storage – in an exchange’s wallet – or use lower security platforms, you can be a target of such an attack and get your crypto stolen.
If that happens, the coins will no longer be under your control. For tax purposes, you won’t have any further obligations about what happens to those coins afterward. The question here is if you can deduct the losses at your cost basis when your coins were stolen/hacked from exchanges or wallets.
Unfortunately, in most cases, you won’t be able to claim a loss. Under the current tax law, this situation is a personal casualty loss, which is no longer tax-deductible. Same for theft loss.
If you’re a victim of a big crypto scam, you should report the case to the FBI. You may be able to claim a loss deduction if you are a qualified investor and you have suffered a qualified loss under Revenue Procedure 2009-20. We recommend that you seek professional advice from a qualified CPA or tax attorney for further details.
Do I need to report stolen crypto on my tax return?
As mentioned above, stolen crypto is a personal casualty loss, which is not tax-deductible. There is no need for you to report your loss anywhere on your tax return.
Do I have to pay taxes on rugged coins?
Let’s imagine that you receive $500K today in a new airdrop. According to the tax regulations in the US, you have to recognize income in the fair market value of the coins you received.
Now, a week later, the founder cashes out and leaves behind investors in what’s called a rug pull. The token price drops to near 0, and your holdings go to near 0.
What is the tax obligation here, assuming that you recognized the airdrop when you received it on day 1?
In this case, you will be able to claim a capital loss because now the coin is worthless. From a logical perspective, you would think the income you recognized and the loss you claimed is a complete offset, and the tax effect is zero.
However, since capital loss only offsets capital gains, not ordinary income, you may end up with a large tax liability due to the airdrop income and a limited capital loss deduction for the year due to the annual $3,000 net loss deduction limitation.
Of course, you can carry forward the remaining capital loss to the following years, but you still end up with a large tax bill for the current year. We understand that it seems unfair. You can probably document the whole process and claim a tax position that no income should be recognized for the airdrop because:
- You didn’t ask for it;
- You had no control over its arrival in your wallet;
- You did not gain any benefit because you were never able to sell the coin before its value went down to zero.
We recommend that you consult your tax advisor for further guidance on your personal situation.
How to claim a loss if I have no way of selling the rugged token?
If the coin is still showing in your exchange or wallet account, it will be difficult to claim a loss unless you can prove that the coin has no fair market value and you cannot sell it anywhere.
There are two strategies we usually suggest our clients do:
- Send the coin to a burn address and burn it;
- Send the coin to a friend in exchange for a nominal amount (e.g., $0.01) and use that amount as your sales proceeds to claim a loss on the sale.
If you received the rugged coin from an airdrop and never reported income on its receipt, then your basis in the coin is zero, and you cannot claim a loss anyway.
I was not a victim of a rug pull, but my coins lost 99% of value. Can I offset it for tax purposes?
In these cases, you need to have evidence that the coin has no Fair Market Value (FMV) and is not listed on any exchange. If you can prove those two conditions, you can claim a worthless coin capital loss deduction in the amount of your cost basis by treating sales proceeds as zero.
I lost my crypto on a boating accident. It was not stolen. Can I claim a loss for tax purposes?
The boating accident story is very common in crypto circles as many holders believe that you can hide your crypto or claim losses if you say you lost all your holdings on such an incident (e.g., boat accident, fires, etc.). However, according to new tax laws, you most likely will not be able to claim an investment loss in these cases because personal casualty losses are not tax-deductible.
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My Bitcoin was destroyed. Can I claim a loss?
You cannot destroy Bitcoin itself. However, let’s say the crypto wallet where you stored your Bitcoin holdings gets destroyed in an accident. Unfortunately, that’s a personal casualty loss, and you wouldn’t be able to claim a tax deduction on it.
CoinTracking is your go-to solution for crypto taxes:
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If you need personalized help reviewing your trades or preparing your US tax returns, check out our CoinTracking Full Service. A team of crypto tax experts led by Sharon Yip, who helped us with this article, provides assistance for CT Full Service.