Tax depreciation possible for bitcoin lost to lending sites like Celsius
Crypto-lending platforms such as Celsius, Anchor, and Voyager Digital became prominent for offering almost incredible returns of up to 20% annually on customer deposits. Much of the cryptocurrency is now trapped, as falling token prices are forcing platforms to temporarily suspend or restrict withdrawals.
In the wake of its own solvency crisis, Celsius – which still advertises up to 18.63% annual return on its website – has had customer funds on ice for more than three weeks and has not yet announced tangible guidance on the next step. So who is going to be left with the bag if these platforms go up?
Unlike the traditional banking system, which usually insures customer deposits, there is no formal consumer protection in place to secure user funds when things go wrong on decentralized financial platforms. ‘High risk, high reward’ is the general motto of the DeFi ecosystem. For those who have lost their savings to these crypto-lending platforms, there is little way to recoup their losses.
But Shehan Chandrasekera, a certified public accountant, told CNBC that the US tax code could provide some relief to these investors in the form of a vague deduction.
“If your funds become totally worthless and irreparable, you may be eligible to write them off as a non-business bad debt on your taxes,” said Chandrasekera, who leads the tax strategy at CoinTracker.io, a digital currency tax software company that helps clients both to track their crypto across virtual wallet addresses and manage their corresponding tax liabilities.
“It’s not going to cover your entire financial loss, but it’s going to give you some sort of tax advantage, because you can at least write off the first investment you make,” Chandrasekera continued.
How to qualify
You can think of a non-business bad debt as a type of loss resulting from a debt extended to another party, which has been made totally worthless and irreparable.
CPA Lewis Taub emphasizes that there must be a complete loss of everything that was lent to the platform for the debt to be considered deductible. Partial losses do not count. Freezing of accounts, or limited withdrawals of crypto platforms, does not constitute a total loss.
At this stage, many of the crypto platforms still call the freezes “temporary” as they find out how they can obtain liquidity, either through restructuring or securing additional lines of credit.
Chandrasekera says that a debt falls into this category “completely uncollectible” only after all attempts at recovery have failed. So technically, none of the cryptocurrencies on deposit on these platforms are completely worthless.
“It is also considered worthless if the borrower files for bankruptcy and the debt is released,” Chandrasekera explained in a tweet thread details on how files can claim the deduction.
However, Taub says that even if a platform declares bankruptcy, the owners can still get something in the probate court, so it is still not a total loss. Voyager Digital, for example, filed for Chapter 11 bankruptcy Tuesday night, but it is not yet clear whether users will be able to recover any of their losses through this process.
It is not always easy to determine if the money you have given to a crypto platform is a loan. For example, cryptocurrencies and stocks, both of which are considered non-debt instruments, do not qualify for this depreciation.
“To have a non-business bad debt, there must be an actual debtor-creditor relationship. So to the extent that crypto was lent to a platform, these criteria are met,” said Taub, director of tax services at Berkowitz. Pollack Brant, one of the largest public accounting firms in Florida.
Ta Celsius. It states in its terms and conditions that any digital asset transferred to the platform constitutes a loan from the user to Celsius.
Not all platforms are equally transparent in their terms and conditions. Neither Voyager nor BlockFi clearly describes the relationship the user has with the platform, according to Chandrasekera, who tells CNBC that they may have left it vague because they do not want to get into it with the Securities and Exchange Commission.
This is also the reason why CPAs recommend that those affected by crypto-platform suspensions contact a financial advisor to see if their investment qualifies.
“You need to talk to a counselor and see, ‘OK, what kind of relationship do I have? Does it look or smell like debt?'” Chandrasekera continued.
“Because if you earn something as a reward, you can argue that it’s an interest income you get,” he said. “So on these platforms, you kind of have to go one by one and see what kind of relationship you have with the platform.”
Claim for deduction
Should the cryptocurrency lending platform meet the mentioned criteria, a person can report the initial value of the cryptocurrency (ie the cost basis) when it was first lent to the platform as a short-term capital loss.
Let’s take the case of a hypothetical crypto investor named Dan, who bought bitcoin for $ 10,000 in 2020. In 2022, Dan lent the same bitcoin, now worth $ 50,000, to a DeFi platform that offers him 15% APY on his bitcoin. This platform then suffers from insolvency pressure and goes into the stomach, making Dan’s debt totally worthless. In that case, Chandrasekera says that Dan will be able to claim his basis for $ 10,000 as a non-business bad debt.
There are certain capital loss constraints to keep in mind, namely the fact that non-business bad debt is always considered a short-term capital loss.
As for Dan, therefore, if he has no other capital gains (from stocks or other cryptocurrencies) in line for this tax year, Chandrasekera says he can deduct $ 3,000 this year from the total loss debt of $ 10,000. and transfer the balance of $ 7,000 to compensate for future capital gains.
As for the actual mechanics for reporting bad debt, the deduction goes to Form 8949 as a short-term capital loss. This is where a user also registers crypto and stock gains and losses.
Chandrasekera notes that you need to attach a “bad debt statement” to the return which also explains the nature of this loss. Among other details, it must include “the efforts you made to collect the debt and why you decided the debt was worthless,” according to the tax authorities.
The IRS warns that if you later recover or collect some of the bad debt you have deducted, you may need to include it in your gross income.
The laundry sales rule
Taub says that these days – to the extent that there are potential losses on actual crypto inventory – he advises clients to take advantage of the fact that ““selling rules” does not apply to crypto. He tells CNBC that investors should really keep an eye on their portfolio to consider “reaping losses” to compensate for capital gains on other investments.
Because the IRS classifies digital currencies as bitcoin as real estate, losses on cryptocurrencies are treated much differently than losses on stocks and mutual funds, according to Onramp Invest CEO Tyrone Ross. With crypto tokens, rules for laundry sales do not apply, which means that you can sell your bitcoin and buy it right away, while with a share you have to wait 30 days to buy it back.
This nuance in the tax code is enormous for crypto holders in the United States, primarily because it paves the way for tax losses to be reaped.
“One thing experienced investors do is sell at a loss and buy back bitcoin at a lower price,” Chandrasekera explained. “You want to look as poor as possible.”
The more losses you can accumulate, the better it is for the investor’s tax situation in the long run.
“You can reap an unlimited amount of losses and carry them over to an unlimited number of tax years,” Chandrasekera added.
Because the clearance sale rule does not apply, investors can reap their crypto losses more aggressively than with stocks, because there is no embedded 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.”
Accruing these losses is how investors ultimately offset their future gains.
When a person goes to liquidate their crypto efforts, they can use these accumulated losses to reduce what they owe to the IRS through capital gains tax.
Quickly buying back the crypto is another important part of the equation. If the time is right, buying dip will allow investors to pick up again if the price of the digital coin goes down.
So let’s say a taxpayer buys one bitcoin for $ 10,000 and sells it for $ 50,000. This person will face $ 40,000 in taxable capital gains. But if the same taxpayer had previously reaped $ 40,000 in losses on previous cryptocurrencies, they would be able to compensate for the tax they owe.
It’s a catchy strategy among CoinTracker users, according to Chandrasekera.
Nevertheless, he warned that thorough bookkeeping is essential.
“Without detailed records of the transaction and the cost basis, you can not substantiate your calculations to the tax authorities,” he warned.
SEE: Bitcoin prices are slipping, the last victim of the crypto winter
