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, did not 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 currency is how they are treated from a tax standpoint. If you own Bitcoin or some other cryptocurrency, you will calculate gains and losses just like you would stock 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 into 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 owning the crypto. In those all-too-common cases, you cannot 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. The IRS regulations specifically state that victims of a Ponzi scheme can claim their losses.
Regardless of what anyone thinks about crypto as a whole, the IRS does expect their gains and losses to be reported on your tax forms, though specific rules regarding crypto are still in flux and not 100% settled.
This article was written by an independent writer for Brewster Financial Planning LLC and is not intended as individualized legal or investment advice.