Crypto News

How to Report Stolen, Lost, or Scammed Coins on Your Taxes

Published
March 14, 2022
Written By
Share

Topics

    Crypto thefts rose five-fold to $3.2 billion in 2021 according to Chainalysis, while scams took another $7.8 billion from unsuspecting victims. In addition, several decentralized finance (DeFi) protocols experienced security breaches, forcing them to dilute existing token holders to cover losses from stolen assets.

    Let's take a look at how to report stolen, scammed, and lost tokens on your taxes.

    Crypto theft and scams are on the rise, but only some of these losses are tax-deductible, thanks to the 2017 Tax Cuts and Jobs Act.

    Can You Deduct Lost Crypto?

    Cryptocurrency transactions are immutable and irreversible by nature, meaning your cryptocurrency is gone forever if you send it to the wrong wallet. Similarly, if you lose the private keys for a software wallet or access to a hardware wallet, it's impossible to modify the blockchain to recover the lost funds in a new wallet. 

    These losses are legally referred to as casualty losses—the damage or destruction of property from a sudden or unexpected event. While casualty losses were deductible in the past, the 2017 Tax Cuts and Jobs Act eliminated casualty loss deductions. The only exception is casualty losses arising from a federally-declared disaster.

    The specific IRS rule states:

    "For tax years 2018 through 2025, if you are an individual, casualty and theft losses of personal-use property are deductible only if the losses are attributable to a federally declared disaster (federal casualty loss)."

    Tldr: No, you cannot deduct lost crypto on your taxes.

    Can You Deduct Stolen Crypto?

    The digital nature of cryptocurrencies makes them especially susceptible to theft. For example, the Federal Trade Commission reckons that Elon Musk impersonators alone stole more than $2 million over the past couple of years. Unfortunately, unlike a stolen credit card or bank account, there's no way to easily and quickly recover the funds. 

    Crypto theft comes in many forms:

    • Crypto Exchange Hacks - Vulnerabilities in crypto exchanges could enable hackers to access users' accounts. For instance, hackers stole over $30 million worth of Bitcoin and Ethereum from Crypto.com in January 2022.
    • Malware - Hackers use malware to steal credentials from users' computers or smartphones. For example, Cryptbot malware—a program that steals a user’s wallet details—raked in nearly a half-million dollars in Bitcoin last year.
    • Physical Theft - Stolen laptops or hardware wallets can result in losses from theft. In addition, hackers have been known to mail compromised hardware wallets to unsuspecting users, enabling them to steal cryptocurrency from them.

    As with casualty losses, the 2017 Tax Cuts and Jobs Act eliminates deductions for theft losses, meaning you cannot deduct these types of losses on your tax return.

    Tldr: No, you cannot deduct stolen crypto on your taxes.

    Can You Deduct Crypto Scams?

    Cryptocurrency scams, or "rug pulls," have become extremely common as the market grows. Unlike theft, crypto scams typically involve investment into a fraudulent scheme. For example, BabyMuskCoin raised $2 million in an initial coin offering (ICO) in a bid to revolutionize meme coins, but the owner ran with the money, and the price crashed to nearly zero.

    Unlike theft or casualty losses, crypto scams fall under the purview of investment losses, making them tax-deductible. You can deduct these losses to offset any capital gains and up to $3,000 of ordinary income during a given year. If your losses exceed these amounts, you can carry the losses forward to future tax years to offset those gains.

    Deduct Stolen Crypto
    ZenLedger makes it easy to compute capital gains or losses. Source: ZenLedger

    You can deduct these losses by computing the total loss, filling out Form 8949, and reporting the total on Form 1040 Schedule D. Then, you can use those amounts to record income on Form 1040 Schedule 1 or Schedule C. Crypto tax software, like ZenLedger, can help connect exchanges and wallets to complete these forms automatically.

    Tldr: Yes, you can deduct scammed crypto as investment losses.

    How to Protect Against Losses

    Tax deductions don't begin to make up for the impact of lost, stolen, or scammed cryptocurrencies—it's much better to avoid losses in the first place. Fortunately, there are several steps that you can take to prevent cryptocurrency losses:

    • Insured Exchanges - Choose crypto exchanges that insure deposits against losses from hacks. For example, Coinbase offers insurance against security breaches arising on its platform, ensuring that its users don’t lose money due to its mistakes.
    • Crypto Insurance - Buy crypto insurance to protect your cryptocurrency from theft. For instance, CoinCover offers personal insurance policies for upwards of $100,000 in the event that a hacker steals crypto from your account.
    • Due Diligence - Use common sense when evaluating crypto opportunities and do your homework on initial coin offerings. For example, read the whitepaper, look for reputable backing, and avoid being pressured to make a purchase in the moment.
    • Cold Storage - Long-term investments are best kept in cold storage where hackers cannot reach them. But of course, you must make sure that you don't lose physical devices or keys by ensuring they’re kept in a safe spot.
    • Diversification - Crypto investors should diversify their holdings to mitigate the negative impact of a single security incident on their entire portfolio. For example, investors staking crypto may choose multiple DeFi networks rather than a single one.

    In addition, investors may want to consider using exchange-traded funds (ETFs) or other investment vehicles that don't involve direct crypto ownership. These funds leverage futures contracts or insurance policies to protect against fraud, eliminating the most common risk factors. However, they typically involve more fees than direct ownership.

    The Bottom Line

    The 2017 Tax Cuts and Jobs Act prevent deductions for casualty or theft losses, but you may be able to deduct scammed crypto as investment losses. While some of these losses are not tax-deductible, you should still inform your accountant or input them into your crypto tax software to ensure accurate tax preparation.

    Even if you can use some deductions, they don't begin to make up for the total losses. So it's critical to do everything you can to protect against these losses in the first place using appropriate due diligence, insurance schemes, cold storage, diversification, and other strategies. 

    If you trade cryptocurrencies, ZenLedger can help ensure that you realize every tax deduction and accurately report your tax liabilities. Our platform automatically aggregates transactions from your wallets and exchanges, computes your capital gains and losses, and auto-fills the IRS forms you need—or integrates with TurboTax to automate the process.

    Try ZenLedger for free!

    Get Started Now

    Simplifying DeFi, NFT, and Crypto Taxes for Investors and Tax Professionals

    FB logolinkedin logotwitter logoyoutubrmedium


    Copyright © 2022 ZenLedger
    10400 NE 4th St, Floor #5,
    Bellevue, WA 98004, USA