Losses from exchange shutdowns, wallet hacks, scams, and other events are unfortunately common in the world of cryptocurrency and NFTs today. However, how these events are taxed can vary depending on the circ*mstances. 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 United States.
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 from 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.
Different crypto loss scenarios
When it comes to deducting or filing cryptocurrency losses, different situations are subject to different tax rules. The most common forms of cryptocurrency losses that we see here at CoinLedger are listed below:
Casualty Loss - (ex. Lost Wallet Access, Sent to Wrong Address)
Theft Loss - (ex. Exchange/Wallet Hacked, Stolen Coins)
Investment Loss - (Gray area = ex. ICO Scam, ExchangeShutdown)
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.
Can I write off lost cryptocurrency?
A casualty loss is damage, destruction, or property loss resulting from one of these identifiable events:
Sudden event — swift, rather than gradual or progressive
Unexpected event — ordinarily unanticipated and unintended
Unusual event — not a day-to-day occurrence
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 as a deduction. 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:
Coins lost from lost access to private keys & wallets
Coins lost from sending to incorrect addresses
Other negligent forms of crypto loss
In these cases, you cannot claim a capital gain or loss on your cryptocurrency.
Can I wrote off stolen cryptocurrency?
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:
Stolen Coins
Hacked Wallets
Hacked Exchange Accounts
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.
Can I write off investment losses?
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 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.
How are rug pulls taxed?
Some cryptocurrency and NFT investors have lost money in a rug pull — a scam where founders promote a project then disappear with the funds, leaving investors with worthless assets.
In cases where there is no market for a rug-pulled asset, you may be able to claim an unrealized loss in certain situations (ex. The asset has no trading volume on exchanges). In this case, there is no reasonable expectation of a return of capital on your investment.
If the asset has liquidity and is still being traded on exchanges, you will not be able to claim a loss until you dispose of it. This is the case even if your assets have lost significant value since you’ve originally received them.
How do I report losses on scam crypto projects/NFT mints?
Occasionally, investors may lose money on crypto tokens or NFTs that turn out to be fraudulent or non-existent. Tax professionals have differing opinions on how to treat these losses on tax returns.
According to Alexander Leruth, Founder & CEO ofLeruths 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 “treat investing in these types of projects as 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 the 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 these types of scams.
Ultimately, claiming a crypto/NFT 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.
How do I report losses due to an exchange shutdown?
Exchange shutdowns like that of Cryptopia and Mt. Gox fall into a grey area of the tax code.
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 on to 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.
How to report your stolen and lost coins with CoinLedger
CoinLedger gives users the option to report lost or stolen coins on their tax returns. Here’s a complete walkthrough of the process.
Simplify your tax reporting today
Looking to file your cryptocurrency taxes? Cryptocurrency tax software like CoinLedger can help.
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As seen on the IRS site, the only property that can be claimed as a deductible casualty is property lost due to a federally-declared disaster. As a result, negligently losing your cryptocurrency would be considered a non-deductible casualty for tax purposes.
You May Be Able to Write Off Crypto Losses If You Sold
"While remaining losses cannot be claimed this year, they can be carried forward to future years and claimed on future tax returns," he said. Still, it's important to remember that you had to have realized the loss for any of this to apply.
You must report income, gain, or loss from all taxable transactions involving virtual currency on your Federal income tax return for the taxable year of the transaction, regardless of the amount or whether you receive a payee statement or information return.
You can claim stolen crypto as a capital loss to offset against your capital gains. But there's a caveat to this - you'll need plenty of proof that your crypto was stolen due to a scam.
Casualty and theft losses are miscellaneous itemized deductions that are reported on IRS Form 4684, which carries over to Schedule A, then to the 1040 form. 4 Therefore, in order for any casualty or theft loss to be deductible, the taxpayer must be able to itemize deductions.
Theft losses are generally deductible in the year you discover the property was stolen unless you have a reasonable prospect of recovery through a claim for reimbursem*nt.
Taxpayers are required to report all cryptocurrency transactions, including buying, selling, and trading, on their tax returns. Failure to report these transactions can result in penalties and interest.
The best idea is to amend your tax return from whichever year(s) you didn't include your crypto trades. You have three years from the date that you filed your return to file an amended return. Some investors fear that submitting an amended return may increase their risk of a future audit.
When reporting your realized gains or losses on cryptocurrency, use Form 8949 to work through how your trades are treated for tax purposes. Then you'll enter this information on Schedule D, which totals up your net capital gains and losses.
Cryptocurrency payments typically are not reversible. Once you pay with cryptocurrency, you can only get your money back if the person you paid sends it back. But contact the company you used to send the money and tell them it was a fraudulent transaction.
However, the refund is limited to the amount that Coinbase can recover from the third-party responsible for the fraud. Coinbase also offers an insurance policy to protect user's funds in case of a breach.
If the loss is from criminal fraud or embezzlement, that is subject to personal loss limits or the limits of itemized deductions. You'll have to go through a process determining what year the loss happened and more importantly if the scam or a Ponzi scheme was already established as a loss.
If your net losses in your taxable investment accounts exceed your net gains for the year, you will have no reportable income from your security sales. You may then write off up to $3,000 worth of net losses against other forms of income such as wages or taxable dividends and interest for the year.
The total of your casualty and theft losses on personal property must be more than 10% of your adjusted gross income (AGI) because only the amount above this limit is deductible.
Start with the total loss for each casualty or theft event to calculate your deduction. Then subtract any salvage value, any insurance or other reimbursem*nts, and $100. Add up the remaining value of each event for the year, and then subtract 10% of your adjusted gross income (AGI) from that total.
While doing so, don't forget to report income you collected from illegal activity or profits from items you stole. Yes, you read that right. IRS guidelines say you must include in your income money made from illegal activities, like dealing illegal drugs or thievery.
If someone steals an asset, the business deducts its value from its total equity. To record this, you can create a theft expense account on your income statement. After subtracting the asset's accumulated depreciation, you can record the amount of stolen capital as a theft expense.
You calculate your loss by subtracting your sales price from the original purchase price, known as “basis,” and report the loss on Schedule D and Form 8949 on your tax return. If your crypto losses exceed other investment gains and $3,000 of regular income, you can use the rest in subsequent years, Greene-Lewis said.
Reporting your crypto activity requires using Form 1040 Schedule D as your crypto tax form to reconcile your capital gains and losses and Form 8949 if necessary. You report your total capital gains or losses on your Form 1040, line 7.
Currently, Coinbase may issue 1099 forms to both you (the account owner) and the IRS if you meet certain qualifying factors. These forms detail your taxable income from cryptocurrency transactions.
No, you do not need to report crypto if you don't sell. Because cryptocurrency and other digital assets are treated as property, taxable events only occur when you realize capital gains or losses through events such as swapping, trading, selling for fiat, or other methods of disposal.
Which crypto exchange does not report to IRS? Several cryptocurrency exchanges, such as KuCoin, OKX (except for P2P trades), and CoinEx, do not collect Know Your Customer (KYC) information or provide 1099 forms for most small traders.
Who gets audited by the IRS the most? In terms of income levels, the IRS in recent years has audited taxpayers with incomes below $25,000 and above $500,000 at higher-than-average rates, according to government data.
Do you need to report taxes on crypto you don't sell? If you buy crypto, there's nothing to report until you sell. If you earned crypto through staking, a hard fork, an airdrop or via any method other than buying it, you'll likely need to report it, even if you haven't sold it.
Crypto losses must be reported on Form 8949; you can use the losses to offset your capital gains—a strategy known as tax-loss harvesting—or deduct up to $3,000 a year from your ordinary income (referred to as the allowable capital loss deduction).
Do I have to pay taxes if I sell crypto at a loss? Selling cryptocurrency at a loss can reduce your tax bill by offsetting capital gains from cryptocurrency, stocks, and other assets.
Do I have to pay taxes if I sell crypto at a loss? Selling cryptocurrency at a loss can reduce your tax bill by offsetting capital gains from cryptocurrency, stocks, and other assets.
As a general rule, Code Section 165 allows taxpayers to deduct a loss from a theft provided that the taxpayer can establish: (1) the occurrence of a theft; (2) the quantifiable loss; and (3) the date that the taxpayer discovered the theft.
Do you need to report taxes on crypto you don't sell? If you buy crypto, there's nothing to report until you sell. If you earned crypto through staking, a hard fork, an airdrop or via any method other than buying it, you'll likely need to report it, even if you haven't sold it.
Reporting your crypto activity requires using Form 1040 Schedule D as your crypto tax form to reconcile your capital gains and losses and Form 8949 if necessary. You report your total capital gains or losses on your Form 1040, line 7.
If you sold crypto at a loss, you can subtract that from other portfolio profits, and once losses exceed gains, you can trim up to $3,000 from regular income, explained Lisa Greene-Lewis, a certified public accountant and tax expert with TurboTax. Plus, there's currently no “wash sale rule” for crypto.
By doing so, you may be able to remove some income from your tax return. If you don't have capital gains to offset the capital loss, you can use a capital loss as an offset to ordinary income, up to $3,000 per year. (If you have more than $3,000, it will be carried forward to future tax years.)
An investor sells a security, such as a stock or a cryptocurrency, at a loss. Within 30 days before or after the sale, the investor buys the same or a substantially identical security. The wash-sale rule applies, and the loss is disallowed for tax purposes.
In essence, you are allowed to report your assets held on FTX as a sale of $0 on the last day of the year when it becomes apparent you will not get your funds back. You will then deduct the cost of the tokens as a capital loss on your Form 8949.
The bottom line: If FTX's assets are insufficient to cover all the claims against it, some creditors will not receive repayment. This means it is possible that account holders who lost money may not be made whole.
FTX has benefited from a recent rise in crypto prices, Dietderich said. Its total recovery would be valued at $6.2 billion based on crypto prices from November 2022, when it filed for bankruptcy after traders pulled $6 billion from the platform in three days and rival exchange Binance abandoned a rescue deal.
The IRS allows you to claim the loss of a cryptocurrency that's been rendered valueless—that is, it has zero market value and is not listed on any exchange—through a process known as abandonment.
Reporting crypto losses using form 8949 and 1040 Schedule D is required by the IRS. Claiming crypto losses on your tax return may allow you to deduct them from your income or offset capital gains, lowering your tax liability.
Even if you earned staking or rewards income below the $600 threshold, you'll still have to report the amount on your tax return. If you've earned less than $600 in crypto income, you won't be receiving any IRS 1099 forms from us. Visit Qualifications for Coinbase tax form 1099-MISC to learn more.
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