Tax write-offs possible for bitcoins stuck on platforms like Celsius

Crypto lending platforms such as Celsius, Anchoras well as Voyager Digital became known for offering almost unbelievable returns up to 20% annually on customer deposits. Now much of this cryptocurrency is trapped as falling token prices force platforms to temporarily suspend or limit withdrawals.

Following your own solvency crisisCelsius – what is still advertising up to 18.63% annual income on their website – customer funds have been frozen for more than three weeks and has yet to announce specific guidance on next steps.

So who will remain at the helm if these platforms fail?

Unlike the traditional banking system, which typically insures customer deposits, there is no official consumer protection to protect user funds when something goes wrong on decentralized finance platforms. “High risk, high reward” is the general motto of the DeFi ecosystem. For those who have lost their savings there are few funds on these crypto lending platforms to recoup their losses.

But Shehan Chandrasekera, a chartered accountant, told CNBC that the U.S. tax code could provide these investors with some relief through an obscure deduction.

“If your funds become completely worthless and irrecoverable, you may be entitled to write them off as non-profit bad debt on your taxes,” said Chandrasekera, a leading tax strategist at CoinTracker.ioa digital currency tax software company that helps clients track their cryptocurrency through virtual wallet addresses and manage their tax bonds.

“It won’t cover all of your economic losses, but it will give you some tax benefit because at least you can write off the initial investment you made,” Chandrasekera.

How can you qualify

You can think of non-profit bad debt as a type of loss arising from debt lent to another party that has become completely worthless and irrecoverable.

CPA Lewis Taub emphasizes that there must be a total loss of everything that has been lent to the platform for the debt to be considered deductible. Partial losses are not taken into account. Account freezes or limited withdrawals by crypto platforms are not a total loss.

At this stage, many crypto platforms are still calling the freeze “temporary” as they figure out how to shore up some liquidity, whether through restructuring or securing additional credit lines.

Chandrasekera says debt only falls into this “completely bad” category after all collection attempts have failed. So, technically, none of the crypto funds on these platforms are completely worthless.

“It is also considered worthless if the borrower files for bankruptcy and the debt is repaid,” Chandrasekera. explained on twitter detailing how applicants can claim the deduction.

However, Taub says that even if the platform files for bankruptcy, holders can still get something in bankruptcy court, so it’s not a total loss. For example, Voyager Digital. filed for Chapter 11 bankruptcy on Tuesday nightbut it is not yet clear if users will be able to recover some of their losses through this process.

Determining whether the money you have given a crypto platform is a loan is not always easy. For example, cryptocoins and shares, which are considered non-durable instruments, cannot be written off.

“In order to have a non-business bad debt, there must be an actual debtor-creditor relationship. So, to the extent that the cryptocurrency has been loaned to the platform, that criterion is met,” said Taub, who is director of revenue at Berkowitz Pollack Brant, one of Florida’s largest accounting firms.

Take Celsius. This is spelled out in its terms that any digital asset transferred to the platform constitutes a loan from the user to Celsius.

However, not all platforms are so transparent in their terms. No one Voyager neither BlockFie clearly describe the user’s relationship with the platform, according to Chandraseker.

This is why CPAs are advising those affected by the suspension of a cryptocurrency platform to contact a financial advisor to see if their investment is eligible.

“You have to talk to a counselor and decide, ‘Okay, what’s my relationship like? Do they look or smell like debt?” Chandrasekera continued.

“Because if you’re earning something like a commission, you can argue that it’s the percentage income that you get,” he said. “So, on these platforms, you have to go through one after the other and see what kind of relationship you have with the platform.”

Withdrawal Application

If a crypto lending platform meets the above criteria, an individual can list the original value of the cryptocurrency (i.e. the underlying value) when it was first granted to the platform as a short-term loss of capital.

Let’s take the case of a hypothetical crypto investor named Dan who bought $10,000 worth of Bitcoin in 2020. In 2022, Dan loaned the same bitcoin, now worth $50,000, to a DeFi platform, offering him 15% interest on his bitcoin. This platform then goes through a bankruptcy crisis and goes bust, rendering Dan’s debt completely worthless. In this case, according to Chandraseker, Dan will be able to claim his foundation. $10,000 as non-profit bad debt.

There are certain limitations to capital loss to keep in mind, namely that non-commercial bad debts are always considered short-term capital losses.

So in Dan’s case, if he doesn’t have other capital gains (from stocks or other crypto investments) planned for that tax year, Chandrasekera says he can subtract $3,000 from his $10,000 bad non-commercial debt total. dollars. this year and carry forward the $7,000 balance to offset future capital gains.

With regard to the actual mechanics of reporting non-business bad debts, the deduction is on Form 8949 as short-term capital loss. Here, the user also registers profits and losses from cryptocurrencies and stocks.

Chandrasekera notes that you should also attach a “bad debt statement” to your return explaining the nature of this loss. Among other things, this should include “the effort you made to collect the debt and why you decided the debt was worthless.” according to the tax office.

The IRS warns that if you later recover or collect some of the bad debt you deducted, you may have to include it in your gross income.

The Washed Sell Rule

Taub says that these days – to the extent that there are potential losses from actual holdings of cryptocurrencies – he advises clients to take advantage of the fact that “laundry sale rules“does not apply to cryptography. He tells CNBC that investors really should watch their portfolio to consider “collecting losses” to offset capital gains from other investments.

Because the IRS classifies digital currencies as bitcoin According to former Onramp Invest CEO Tyrone Ross, losses from cryptocurrency holdings are viewed very differently from losses from stocks and mutual funds. With crypto tokens, laundry sale rules do not apply, which means you can sell your bitcoin and buy it right away, whereas with stocks you have to wait 30 days to buy it back.

This nuance in the tax code is of great importance for cryptocurrency holders in the US, primarily because it paves the way for collection of tax losses.

“One thing savvy investors do is sell bitcoin at a loss and buy it back at a lower price,” Chandrasekera explained. “You want to look as poor as possible.”

The more losses you can take, the better for the investor’s tax situation in the long run.

“You can collect unlimited losses and carry them forward for an unlimited number of tax years,” Chandrasekera added.

Since the fictitious sale rule does not apply, investors can recoup their losses in cryptocurrency more aggressively than with equities because there is no waiting period.

“I see people doing this every month, every week, every quarter, depending on their sophistication,” he said. “You can collect so many of these losses.”

The accumulation of these losses is how investors end up offsetting their future gains.

When a person is about to liquidate their stake in a cryptocurrency, they can use these collected losses to reduce their debt to the IRS through capital gains tax.

Fast cryptocurrency buybacks are another key part of the equation. If timed correctly, buying on a dip will allow investors to bounce back if the price of the digital coin recovers.

So let’s say a taxpayer buys one bitcoin for $10,000 and sells it for $50,000. This person faces $40,000 in taxable capital gains. But if that same taxpayer had previously incurred a $40,000 loss from earlier cryptocurrency transactions, they could have been able to offset the tax owed.

According to Chandraseker, this strategy is gaining popularity among CoinTracker users.

However, he warned that careful bookkeeping was necessary.

“Without detailed records of your transactions and cost basis, you will not be able to substantiate your calculations to the IRS,” he warned.

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