Tax writeoff possible for bitcoin lost to lending sites like Celsius

On Jul 6, 2022

Crypto lending platforms like Celsius, Anchor, and Voyager Digital rose to prominence for offering almost unbelievable returns of up to 20% annually on customer deposits. Now, much of that crypto cash is trapped, as plunging token prices force platforms to temporarily suspend or limit withdrawals.

In the wake of its own solvency crisis, Celsius — which is still advertising up to 18.63% annual yield on its website — has had customer funds on ice for more than three weeks and has yet to announce tangible guidance on next steps. So who is going to be left holding the bag if these platforms go belly up?

Unlike the traditional banking system, which typically insures customer deposits, there aren’t formal consumer protections in place to safeguard user funds when things go wrong on decentralized finance platforms. ‘High risk, high reward’ is the general motto of the DeFi ecosystem. For those who lost their life savings to these crypto lending platforms, there is little recourse for recouping their losses.

But Shehan Chandrasekera, a certified public accountant, tells CNBC the U.S. tax code may provide some relief to these investors by way of an obscure deduction.

“If your funds become totally worthless and irrecoverable, you may be eligible to write them off as a nonbusiness bad debt on your taxes,” said Chandrasekera, who heads up tax strategy at CoinTracker.io, a digital currency tax software company that helps clients to both track their crypto across virtual wallet addresses and manage their corresponding tax obligations.

“It’s not going to cover up your entire economic loss, but it’s going to give you some type of tax benefit, because at least you get to write off that initial investment that you put in,” continued Chandrasekera.

How you might qualify

You can think of a nonbusiness bad debt as a type of loss resulting from a debt extended to another party, which has been rendered totally worthless and irrecoverable.

CPA Lewis Taub stresses that there must be a complete loss of all that was lent to the platform in order for the debt to be considered deductible. Partial losses don’t count. The freezing of accounts, or limited withdrawals by crypto platforms, does not constitute a total loss.

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

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

“It’s also deemed worthless if the borrower files for bankruptcy and the debt is discharged,” Chandrasekera explained in a tweet thread detailing how filers could claim the deduction.

However, Taub says that even if a platform declares bankruptcy, the holders may still get something in bankruptcy court, so it’s still not a total loss….