FTX Users Can’t Count on Help From the IRS



When market investors suffer losses, or are misled, they are often eligible for a tax deduction to soften the blow. Users of the bankrupt FTX crypto exchange will not be so lucky.

Here’s the difference: Let’s say you’re a cryptocurrency investor on an exchange that’s still going strong. If you’ve suffered investment losses amid the market crash, you can simply sell to offset other gains and potentially take a deduction. This is because the Internal Revenue Service allows investors to sell underperforming cryptocurrencies, just like stocks, and use those losses to write off capital gains from selling better performing assets.

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

But that is not the case for clients of FTX or any other cryptocurrency exchange that it exploits. The tax code specifies that if you want to take a capital loss, you must sell or trade that asset. Losing access because the exchange shuts down is different and would likely be insufficient in court, said Matt Metras, an accountant in Rochester, New York, who represents taxpayers before the IRS.

Another provision of the code allows for a deduction if a security has no value. No luck, though: The IRS has said that the digital currency is considered property, not a security, like a stock. Also, the asset has to be worthless, like at zero, not close to that.

Then there’s the robo-loss route, but it’s tricky. Before the 2017 Republican tax law, investors who had theft losses could deduct them from their ordinary income as long as certain criteria were met. Along with a bunch of other miscellaneous itemized deductions, the theft loss deduction has been largely eliminated, except for losses tied to a federally declared disaster.

An FTX user’s best bet when filing taxes next April may be to try to take advantage of a special theft-loss rule provision (created after the Bernie Madoff scandal) that still allows for a write-off if the loss is due to a Ponzi scheme. But the loss has to meet some strict requirements to qualify. For example, the investor must show that he expected a profit and the perpetrators must have had the specific intent to mislead investors.

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

Keep in mind that the theft loss deduction is moot if you plan to take the standard deduction instead of itemizing it. The theft loss deduction is only for those who itemize because they receive a higher write-off for deducting items like mortgage interest and charitable contributions separately.

Some crypto investors in the bankrupt platform Celsius Network, which offered high returns in exchange for crypto, may consider another tax play, but it seems a long shot. If they can show that they made a loan to these platforms and that their entire investment has become worthless and cannot be recovered, then they may be eligible for what is known as a non-business bad debt deduction.

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

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

More from Bloomberg’s opinion:

• Tax loss harvesters, prepare for a bountiful harvest: Alexis Leondis

• FTX offers a master class on the failures of the crypto market: Editorial

• AI can help make cryptocurrencies safer for everyone: Tyler Cowen

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

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, he oversaw tax coverage for Bloomberg News.

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