Can Taxpayers Deduct Losses on Abandoned or Worthless Cryptocurrency?

Since their creation in 2009, cryptocurrencies have been polarizing, especially when it comes to taxes, bringing both opportunities and challenges. While you must pay income taxes on income and gains made from cryptocurrency investments, the question of whether you can deduct losses from abandoned or worthless cryptocurrencies is still a hot topic.

Abandonment or worthlessness happens when you give up ownership and control over a cryptocurrency because it lost value, it turned out to be a scam, a project failed, etc. According to the IRS, abandonment is proven through an evaluation of surrounding facts and circumstances, which must show an intention to abandon the property, along with an affirmative act of abandonment. Once a cryptocurrency is abandoned, it is considered worthless, or dead. Determining whether the cryptocurrency is worthless is also the responsibility of the taxpayer. The determination should be based on concrete evidence indicating that the crypto holds no value anymore. The assumption of worthlessness is frequently made from an identifiable event, like bankruptcy, liquidation, or the cessation of operations. Nevertheless, the presence of such an event is not always obligatory to assert worthlessness, especially if the crypto is entirely insolvent. Even though the judgment of worthlessness is commonly based on an individual perspective, courts typically have supported it in cases where there is no realistic chance of investors obtaining any valuable returns.

According to IRC Sec. 165(a), it is permissible to claim a deduction for losses incurred during the taxable year that have not been compensated for by insurance or other means. These losses are eligible for deduction only in the same year they occur. Section 165(g) provides that if a security becomes worthless within the taxable year, the loss is treated as a loss from sale or exchange of a capital asset. Unfortunately, cryptocurrency is not currently considered a security by the IRS under IRC Sec. 165(g)(2). In this code section, a security is defined as a corporation’s stock share, subscription rights for, or right to receive, a share of stock in a corporation, or a bond, debenture, note, or certificate or other evidence of indebtedness, issued by a corporation or government or political subdivision thereof, with interest in coupons or in registered form. Additionally, the IRS classifies cryptocurrency as property under Notice 2014–21. Therefore IRC Sec. 165(g) does not appear to apply to crypto.

Treas. Reg. section 1.165-2(a) provides that a taxpayer experiences a loss under IRC Sec. 165(a) when there is a loss of utility in nonpredictable property provided that the loss occurs in a business context or a profit-oriented transaction, the loss emerges due to the sudden termination of usefulness in the business or transaction and the property is permanently removed from use, or the transaction is brought to an end. For individual taxpayers, IRC Sec. 67(b)(3) characterizes section 165(a) losses, other than those from casualty, theft, and wagering, as miscellaneous itemized deductions. On the other hand, IRC Sec. 67(g) disallows all miscellaneous itemized deductions for tax years beginning after December 31, 2017, and before January 1, 2026. As such, one should consider selling cryptocurrencies at a loss before they become worthless, or are considered abandoned.

As the world of cryptocurrencies and their taxation continues to change, it is imperative to stay well informed about tax regulations and seek professional advice when dealing with your crypto investments.