Bitfinex Hack — How to Deduct the Loss on Your U.S. Taxes
Summary: Max $3,000 capital loss if losses > gains. Theft Loss: Possible if itemize deductions & loss > 10% of adjusted gross income. Depends on facts and circumstances.
Bitfinex was hacked by person(s) unknown on August 2, 2016 and 119,756 BTC was stolen from customer accounts, valued at approx. 60,000,000 USD. This attack did not target the exchange’s hot wallet, but drained Bitcoin from the individual, multi-signature wallets held by customers.
It may be small consolation for the US users of Bitfinex, but IRS tax rules allow you to take a loss for the stolen Bitcoins.
Unfortunately, with a hack of this size it’s possible that many users lost all Bitcoins held on Bitfinex. The exchange is still offline as of August 5, and it’s unknown to what extent the exchange will cover customer losses. Bitfinex’s site had this statement at 05 Aug 2016 at 12:09 AM (UTC):
“we are leaning towards a socialized loss scenario among bitcoin balances and active loans to BTCUSD positions.”
For US persons reporting the loss on their tax return, the basic question is whether this will be a capital loss, or a theft/casualty loss. The characterization of the loss has very different tax consequences. Also, if Bitfinex provides partial reimbursement of losses, this will affect the loss calculation.
This post will summarize the rules, but individual taxpayer circumstances vary widely and we are NOT stating which position you should adopt for your tax return. Please consult your tax advisor.
Per the IRS, Bitcoin and other virtual currencies are property, and Bitcoin is generally treated as a capital asset. Individuals report Bitcoin sales on Schedule D, together with sales of other capital assets, such as stocks or bonds.
Under capital loss treatment, Bitcoin which becomes completely worthless during the year would be treated as if sold on the last day of the year. Cost basis of the Bitcoin is the original cost in USD of the Bitcoin, and sale proceeds = zero.
Capital loss = the original purchase price in USD, not the value at the time of the hack.
The capital loss offsets any capital gains. If losses are greater than gains, you can take a max $3,000 loss for the year. Any unused capital losses carry forward to future years, and never expire.
Per the IRS, a theft is the taking or removing of money or property with the intent to deprive the owner of it. Bitcoin is property, so the theft of Bitcoin could qualify as a casualty loss.
The deduction for a theft loss is an itemized deduction on Schedule A. It is only available for taxpayers who itemize deductions and do not use the standard deduction.
Unfortunately, you can only deduct losses in excess of 10% of your adjusted gross income (AGI). Let’s assume AGI = 75,000 for the example below:
Original purchase price Bitcoin stolen in hack = 10,000
Reimbursement from Bitfinex = 5,000
Subtotal loss = 5,000
Reduce loss by 100 per IRS rule (100)
Loss after $100 rule = 4,900
Subtract 10% of 75,000 AGI (7,500)
Theft Loss Deduction = ZERO
Unfortunately, since 10% of AGI is larger than the loss, you cannot take a theft loss deduction.
However, there any many scenarios in which the taxpayer could take the loss:
larger loss with the same income, or
larger loss combined with lower income.
In addition, if the loss is partially reimbursed in Bitcoin this introduces additional complications.
Cross-posted to http://globaltaxaccountants.com/custom1.php
The above general comments concern the United States federal tax treatment of capital and theft/casualty losses. State tax issues were not addressed and the comments DO NOT APPLY to any country/jurisdiction other than the United States. Tax law is complex and taxpayer circumstances vary widely. These are general comments which are absolutely NOT intended to apply to a particular taxpayer’s situation. Under IRS Circular 230, I have no responsibility for any positions you take on your tax return, unless I have prepared and signed that tax return. For detailed analysis of your tax situation, please consult your tax advisor.