In 2019, over $4.9 billion worth of cryptocurrencies fell prey to crimes like theft and hacks.
Over 20% of all Bitcoins are lost and forever gone.
Over $9 million worth of crypto scams take place every day.
What do these stats tell us?
It tells us that lost and stolen cryptocurrencies are much more common occurrences than we would like to think.
These incidents can take place in many ways – you may forget your private keys, your wallet may get hacked or stolen, you may send crypto to the wrong address, or something quite popular these days, exit scams, rug pulls, and other kinds of crypto scams.
However, we are not here to discuss exit scams and rug pulls or how to keep your crypto safe. That’s a topic for another time.
In this article, we will discuss how you, as a taxpayer, can report your lost and stolen cryptocurrencies as losses. Crypto tax is already a complex subject because of the lack of clarity and guidance, and reporting lost or stolen crypto as losses are even trickier, and we’ll explain why.
But first, we must understand the different kinds of losses and how to qualify for them. There are mainly four of them –
- Casualty Losses
- Theft Losses
- Investment Losses
- Abandonment Losses
Casualty losses are losses caused by a sudden or unexpected event.
However, in 2021, the casualty losses law is almost non-existent. After the Tax Cuts and Jobs Act, passed in 2017, most forms of casualty losses are no longer deductible on Form 4684 except for any casualty that qualifies as a federally declared disaster.
Luckily, the Tax Cuts and Jobs Act will be lifted again in 2025. However, until then, this is all we have.
So, in the context of cryptocurrencies, casualties caused by your own negligence don’t qualify for losses, which means you won’t receive a tax break on losing your private keys, sending your crypto to the wrong address, or other similar casualties.
Theft losses are pretty self-explanatory and, in a lot of ways, similar to casualty losses.
In simple words, theft losses include casualties when someone steals your property or asset with criminal intent.
So, in the context of cryptocurrencies, theft loss may include but is not limited to – Stealing private keys and wallets, hacking wallets, or exchange accounts.
However, much like casualty losses, theft losses no longer qualify for deductions on Form 4684 thanks to the Tax Cuts and Jobs Act.
Note: There are other ways to work around these losses, but as some tax professionals and experts suggest, every case is different and unique and involves a lot of nuances. Hence, it’s a pretty risky position to be in without the guidance of a tax professional or attorney.
Capital losses, also known as investment losses, are the most common form of losses. It refers to the loss you incur when you invest in an asset with the intent to make a profit.
In other words, when the cost basis is higher than the selling price.
Even though the IRS classifies crypto as property, people use it for many purposes. That’s why it’s important you understand the distinction between purchasing crypto with the intent to make a profit and purchasing crypto to do day-to-day transactions.
Many people believe that crypto scams and exchange shutdowns should also qualify as capital losses.
But it’s not that simple.
Crypto scams and exchange shutdowns fall under the casualty losses or theft losses categories. But it’s not the answer you probably wanna hear because, as we mentioned before, those laws pretty much don’t exist anymore.
However, we need to understand that there are certain criteria for qualifying a loss as a capital loss that exit scams and exchange shutdowns fail to do.
For example, one such criterion is that a “sale or exchange” must take place to qualify for a capital loss.
“Sale,” as we know, is the disposing of an asset for fiat currency, while “exchange” is the disposing of one asset for another.
And guess what?
In exit scams and exchange shutdowns, there is neither a sale nor an exchange. Instead, the crypto is just gone, disappeared. Hence, it can’t be treated as a capital loss… in theory.
Some tax professionals and attorneys claim that there are still ways to work around it. But as we mentioned before, it’s a risky position to be in.
Whether you lost your crypto, it got stolen, or you got scammed, from what we know so far, it seems like all hope is lost, as there are no tax provisions to solve this dilemma.
Except one. Probably.
The abandonment loss is the most overlooked yet probably the only plausible option for someone in this situation.
Abandonment loss occurs when you deliberately and intentionally give up ownership and possession of your property.
However, in order to qualify for abandonment losses on your lost or stolen crypto, you must establish that you –
- Purchased the property or asset with the intent to make a profit.
- Have taken appropriate actions and evidence-based measures to prove your intent to abandon your property.
Other than this, there are a few more criteria that you must meet to qualify for abandonment losses. Nonetheless, it’s still better than nothing, and with the help of a professional, you might very well succeed.
After looking at the different kinds of losses and tax provisions, it’s pretty evident that there is very little chance you can claim losses on lost and stolen crypto.
Even though abandonment loss might seem like the only way out, it isn’t.
Because, as we discussed before, there are different criteria you must meet for different losses, and some of these can get overly complicated and nuanced real fast.
That is why it’s always a good idea to consult a tax professional who knows what they are doing and can guide you through your particular situation.