Last week, the news broke that hackers had made off with $500 million worth of cryptocurrency from Coincheck, a popular Bitcoin exchange. This theft shattered the previous world record, a staggering $400 million in Bitcoin stolen from the Mt. Gox exchange in 2014.
Major exchanges have gotten the most media attention, but they are not the only victims of coin theft. Hacking is a major problem for the crypto community, and most of us are vulnerable to some degree. On the bright side, however, if you get hacked you can probably get a financial break from the IRS.
In general, the IRS allows taxpayers to deduct losses from the theft of money or property. However, this deduction is only available for people who qualify. If you’ve been hacked, contact a tax professional to discuss whether you may be able to recover some of your loss through a tax deduction. Happy Tax can connect you to a cryptocurrency-trained accountant available to speak with you right away.
Common Cryptocurrency Security Pitfalls
Hackers were able to steal about $500 million worth of cryptocurrency from Coincheck due to one critical security flaw: poor wallet management. This is a problem that impacts everyone in the cryptocurrency community, from the largest exchanges to the first-time user. Fortunately, however, there are some basic practices you can follow to hack-proof your cryptocurrency wallet.
If you keep your currency on an exchange like Coinbase or Bitstamp, the company holds the private key to the wallet where your coins are stored. As the 260,000 Coincheck customers impacted by the recent hack can tell you, this is not the most secure option for storing your coins. Although all of us are potential targets, exchanges are particularly attractive marks for cybercriminals. So, the first step to keeping your coins secure is to move them into a secure wallet with a private key you hold yourself.
Hackers can steal your private key by accessing its storage location by spying on your communications. You can protect your private key by encrypting your wallet and requiring multisig verification. However, the only way to completely prevent hacking is to keep your wallet and all security information offline using hardware wallets. Cryptocurrency stored in a so-called “cold storage” wallet is completely inaccessible by third parties, and following the proper procedures will make sure your wallet is 100 percent secure.
If you are the unfortunate victim of a cybercrime, it’s hard to know what to do next. It is very difficult, often impossible to recover coin stolen from a breached virtual currency wallet. So, if you want to make sure your coins are secure, follow the standard best practices for cold storage and private key management. If hackers or schemers do get their hands on your coin, however, it’s critical to be proactive in getting your money back. If you believe you’ve been the victim of a cybercrime, report it to the proper authorities right away. If you are unable to recover your coin, you may be entitled to some degree of compensation on your tax return.
Tax Breaks for Cybercrime Victims
If the worst does happen, there is a silver lining to your financial loss. The IRS usually allows you to deduct any cryptocurrency you lost due to theft or fraud. So, if computer hackers empty your wallet or you invest in a new coin that turns out to be fraudulent, you may be able to recover some of your loss on your tax return.
Under the tax code, “theft” covers all criminal means of appropriating another person’s property, including swindling or false pretenses. This definition is tied to the criminal code in each taxpayer’s particular jurisdiction, as theft for tax purposes requires criminal intent.
If your circumstances substantiate a theft loss, the amount of your deduction depends on whether the theft occurred in a for-profit transaction or an unrelated activity. If your coins were stolen in some manner not connected to a transaction entered into for profit, you can only deduct losses that exceed 10 percent of your adjusted gross income, minus $100. So, how much you can deduct depends on how much money you made in that particular year. Also, because the theft loss is an itemized deduction, if you take the standard deduction you may see no tax benefits on the loss.
If you lost cryptocurrency in a dubious Initial Coin Offering (“ICO”), you might not be able to take the theft loss deduction due to the criminal intent requirement. In these cases, you may still be able to write off your costs as a capital loss. Even if the ICO turns out to have failed due to fraudulent activities of the company’s officers and directors, a loss from stock tradable on the open market is almost always treated as a capital loss. However, you can only deduct up to $3,000 in capital losses, so your financial recovery is limited.
If You’ve Been Hacked, Call a Professional
If you’ve been the victim of a hack, it’s important to know what options you have to recover your money. Even if cybercrimes investigators can’t track down your virtual currency, the IRS may give you a tax break. While this cannot make you whole again, it can at least help offset your loss. However, whether you qualify for a theft or capital loss deduction can be a complex determination, and it’s important to get everything straight before you send your tax return to the IRS.
If you’re among the millions of investors impacted by theft or fraud in the cryptocurrency market, consult with a tax professional right away. Happy Tax Certified Professional Accountants review every customer’s tax return, and they can provide you with the advice and assistance you need to take advantage of every tax break you can. Happy Tax also provides specialized training to all of its tax preparers, making sure they are up-to-date on all current cryptocurrency tax policies. Contact a Happy Tax cryptocurrency accountant today to discuss how you might be able to save on your taxes this year.