FTX Users Can’t Count on Help From the IRS

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When market investors suffer losses – or are taken for a ride – they are often entitled to a tax write-off to soften the blow. Users of the bankrupt crypto exchange FTX will not be so lucky.

Here’s the difference: Let’s say you’re a crypto investor on an exchange that’s still standing. If you suffered investment losses amid the market downturn, you can simply sell to offset other gains and may take a deduction. That’s because the Internal Revenue Service allows investors to sell underperforming cryptos, just like stocks, and use those losses to cancel out capital gains from selling better-performing assets.

If losses exceed gains, investors can deduct up to $3,000 against their taxable income. Losses over $3,000 can be carried forward each year until death to offset gains in future years.

But that’s not the case for customers at FTX or any other crypto exchange that blows up. The tax code states that if you want to take a capital loss, you must sell or exchange that asset. Losing access to the exchange is different because the exchange shuts down and probably wouldn’t be sufficient in court, said Matt Metras, an accountant in Rochester, New York, who represents taxpayers before the IRS.

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Another provision in the code allows a deduction if a security is worthless. No luck, though – the IRS has said that digital currency is considered property, not a security, like a stock. In addition, the asset must be worthless, as in zero — not close to it.

Then there is the way of theft-loss, but it is complicated. Before the 2017 Republican tax law, investors who had losses due to theft could deduct them against their ordinary income provided certain criteria were met. Along with many other miscellaneous itemized deductions, the theft-loss deduction was largely eliminated except for losses related to a federally declared disaster.

An FTX user’s best bet when filing tax returns next April may be to try to take advantage of a special provision for the theft rule (created after the Bernie Madoff scandal) that still allows write-offs if the loss is due. Ponzi scheme. But the loss must meet some strict requirements to qualify. For example, the investor must show that she had an expectation of profit, and the makers must have had a specific intention to attract investors.

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FTX founder Sam Bankman-Fried has not been charged with a crime. Advisors overseeing what’s left of FTX are scrambling to find the company’s cash and crypto, according to a bankruptcy court filing.

Keep in mind, the theft-loss deduction is a concern if you intend to take the standard deduction instead of itemizing. The stolen-loss deduction only applies to those who itemize because they get a bigger write-off for deducting items like mortgage interest and charitable gifts separately.

Some crypto investors on the bankrupt Celsius Network platform, which offered high returns in exchange for crypto, could consider another tax play, but it seems like a long shot. If they can show that they have taken out a loan with these platforms and their entire investment has become worthless and cannot be recovered, then they may be eligible for a deduction called bad non-business debt.

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But that’s a high bar. Not enough because accounts are frozen or withdrawals are limited. And bankruptcy doesn’t automatically mean the entire debt is worthless, Phil Gaudiano, a certified public accountant in Great Falls, Virginia, warned in an op-ed for CoinDesk.

Which is to say that crypto investors who got burned badly this year shouldn’t expect any relief from the IRS.

More from Bloomberg Opinion:

• Tax Loss Harvesters, Prepare for a Bumper Crop: Alexis Leondis

• FTX Offers Master Class in Crypto Market Flashes: Editing

• AI Can Help Make Cryptocurrency Safer for Everyone: Tyler Cowen

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Before that, she oversaw tax coverage for Bloomberg News.

More stories like this are available at bloomberg.com/opinion

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