Tax Challenges for Crypto Investors Affected by FTX Collapse

The FTX collapse in November 2022 left many crypto investors in a quandary about filing taxes related to their FTX transactions.

While there has been conflicting information about the right approach, the lack of a specific tax law addressing this unique situation adds to the confusion.

Dissecting the Internal Revenue Code Limitations

FTX, once a popular crypto exchange, filed for bankruptcy after it failed to meet customer withdrawal demands. This has led to uncertainty for affected investors. Especially since the tax law doesn’t offer a straightforward method to deduct losses associated with the collapse.

David Canedo, Head of Compliance and Tax at Accointing, explained that one possible method for deducting losses is using the worthless security deduction under 26 U.S. Code section 165. Still, this poses two major issues.

First, cryptocurrencies are not considered stock or security under the Internal Revenue Code. This inconsistency makes it difficult to utilize this provision for FTX-related losses.

Second, the losses aren’t considered “total” yet. FTX has notified users about their claims and amounts but hasn’t provided a specific process or timeline for submitting claims. Until the actual amount of loss is determined, it’s impossible to write them off for tax purposes, affirmed Canedo.

Given the uncertainty surrounding the bankruptcy proceedings, affected investors may have to wait until 2024 to determine their actual losses. Even then, the recovery of funds is not guaranteed, and the final amounts may differ significantly from expectations.

How to File Crypto Taxes After FTX Collapse

In light of these complexities, the best course of action for crypto investors may be to wait. While this may not be ideal for those eager to resolve their tax situations, the alternative could be taking a controversial position.

It might be worthwhile to consult a tax professional for investors who lost a substantial amount and have other capital gains to offset. These experts can help navigate the intricacies of the tax law to find a way to claim deductions, with some risk involved.

Another approach, suggested by Canedo, involves selling FTX claims, which could make the losses deductible. This option carries its own set of challenges and potential legal pitfalls. Moreover, this might not be the best course of action due to the risk of further complicating tax matters.

The FTX collapse has highlighted the need for regulatory bodies and tax professionals to adapt to the fast-paced crypto industry. As cryptos continue to gain prominence, lawmakers must stay informed and develop relevant guidelines.

In the meantime, affected FTX investors should keep a close eye on developments in the case and maintain open communication with tax professionals. This will ensure they remain prepared to make the best decisions possible when the time comes to file their taxes.