Victims of Crypto and NFT Fraud Can Take Theft Loss Deductions
Bitcoin grew to become a information sensation in 2017, when its worth skyrocketed virtually in a single day to $20,000 per coin. A number of years later, the non-fungible token additionally gained notoriety. Promoters of NFTs claimed that their uniqueness would flip them into collectibles, creating demand that will result in a revenue in the event that they had been later offered.
Regardless of the potential and guarantees, many cryptocurrencies and NFTs have gone bust in latest months, with swaths of buyers dropping most, if not all, of the worth. In some instances, the creators and promoters had been merely unable to attain the targets they promised. However others had been scams wherein the creators had no intention of repaying their buyers and would disappear after taking the buyers’ cash, also referred to as rug pulls.
Whereas most crypto and NFT fraud victims is not going to get their investments again, they are able to benefit from tax advantages as a result of their losses. Probably the most useful is the theft loss deduction, which can be utilized to offset bizarre revenue, though the Tax Cuts and Jobs Act has restricted its use for private losses.
The IRS’ definitive steerage in regards to the US tax therapy of cryptocurrency is in Notice 2014-21. It states that, generally, such foreign money is handled like property, so the value paid for the cryptocurrency turns into the fee foundation. Whether it is later offered, there’s a capital acquire or loss on the transaction. This discover is prone to apply to NFT transactions as nicely. Sadly, some taxpayers is not going to be pleased with taking a capital loss, as they might not have capital positive aspects to offset the losses. In addition they might favor to deduct the loss towards their bizarre revenue, notably if they’re in a excessive tax bracket.
Previous to 2018, losses as a result of theft may very well be deducted as an itemized deduction, however the TCJA restricted the theft loss deduction to losses attributable to a federally declared catastrophe till 2025. Since cryptocurrencies haven’t been linked to a federally declared catastrophe, a taxpayer will be unable to assert a private theft loss.
There’s a particular exception for victims of Ponzi-type funding schemes. In 2009, the IRS revealed Revenue Ruling 2009-9 to supply tax aid to the victims of Bernie Madoff’s $64 billion Ponzi scheme. On this ruling, the IRS said that if any cash put into an funding account with the expectation of revenue and is discovered to be fraudulent, any loss is taken into account a enterprise theft loss and never a private theft loss. Due to this fact, the private theft loss limitation said above doesn’t apply. Lastly, if the losses exceed the taxpayer’s revenue for the yr, they’re thought of internet working losses and both might be carried ahead to offset future revenue or carried again, which permits the taxpayer to assert a refund.
To say this particular theft loss, the taxpayer can declare the theft loss as they usually would, so long as they meet the necessities of above income ruling. Alternatively, the taxpayer can use an elective protected harbor process outlined in Revenue Procedure 2009-20, which was launched concurrently with the income ruling. To satisfy the protected harbor, the lead determine within the funding scheme have to be charged (however not convicted) with prison fraud, theft, or embezzlement, and the taxpayer should declare the theft loss on the yr the prison fees are filed. The losses claimed are restricted to 95% of the losses if the taxpayer is just not pursuing third-party restoration or 75% of the losses if they’re pursuing third-party restoration. The loss quantity is additional deducted by any quantities truly recovered and fairly prone to be recovered sooner or later.
Whereas the tax advantages can considerably ease the monetary ache of rug pull victims, not everybody will have the ability to declare the theft loss. As a result of the loss is an itemized deduction, the taxpayer should first be certain that their whole itemized deductions exceed the usual deduction for the yr. For instance, somebody who has no giant medical bills, pays little state and native taxes, has no mortgage curiosity funds, and doesn’t give to charity is just not doubtless to have the ability to declare the theft loss.
Assuming the taxpayer qualifies for the itemized deduction, the following query is whether or not they suffered a deductible theft loss. Theft is obvious if the perpetrators are criminally charged with fraud or embezzlement, however was the taxpayer anticipating a revenue on their crypto or NFT transaction? And what about NFTs or cryptocurrencies that merely didn’t obtain the market worth that the investor was anticipating, even when the anticipated worth was promised by the promoters?
In Revenue Ruling 77-17, the IRS held {that a} theft loss deduction can’t be taken on the worthlessness or disposition of inventory, even when the decline was as a result of fraudulent actions of the company’s officers and administrators, as a result of they didn’t have the precise intent to deprive the shareholder of cash and property. A theft loss may very well be denied for the loss in worth of a cryptocurrency or NFTs beneath comparable circumstances.
Whereas the IRS’ theft loss steerage in 2009 utilized primarily to the Madoff Ponzi scheme victims, it hasn’t been withdrawn. If the taxpayer bought an NFT or cryptocurrency with an expectation of a revenue sooner or later, they need to be entitled to take the theft loss with out the constraints imposed by the TCJA.
This text doesn’t essentially mirror the opinion of The Bureau of Nationwide Affairs, Inc., the writer of Bloomberg Regulation and Bloomberg Tax, or its house owners.
Creator Data
Steven Chung is a tax lawyer in Los Angeles. He’s additionally a weekly columnist on the authorized weblog Above the Regulation, the place he writes about taxes, solo and small regulation agency apply, and managing scholar loans.
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