Hello everyone! I wanted to reproduce a post I made on Reddit earlier today.  If you want to see the original feel free to check it out here.  Not to belabor the point, but I’m not a tax professional, so please do your own homework and/or consult an expert before relying on this post.  And with that, here’s the article:

I was reading through the instructions for IRS Form 4684 for 2014 and it seems like there are a couple scenarios where Bitcoin losses might be tax deductible. Full disclosure I’m not a tax professional or expert and you should consult your own tax adviser before filing anything or making decisions.

CAPITAL LOSS Selling trading, or purchasing goods with Bitcoin can be reported as a capital loss on Schedule D, if the fair market value on the date of sale was less than the adjusted basis. This is the standard way that most US Bitcoiners will have to report Bitcoin losses or gains to the IRS. This is also covered in depth by others who know more than me so I won’t go into more detail.

THEFT Bitcoins that were stolen from you qualify for Form 4684, providing you can prove, in accordance with IRS Pub 547, that the coins were yours and that they were stolen. For example the Coinapult theft earlier this month would seem to meet the IRS requirements for this type of loss of an individual’s Bitcoins. Proving the stolen coins were yours if the IRS questions your return is a tough but solvable issue, but I’m not really sure how anyone could prove the coins were stolen in the first place. This seems like a huge trust/credibility gap that any exchange or service has to overcome when reporting that funds were stolen. How does the IRS, or a customer for that matter, know that the wallets where the funds now reside are not also controlled by the party claiming loss? This complication makes claiming a loss due to theft a bit risky in my mind, but others may disagree.

Pub 547 also provides special rules which apply specifically to Ponzi scheme losses; however, the guidance specifically excludes mislaid or lost property from meeting the definition of a theft. This would indicate if you simply lost/erased your private keys or accidentally sent your Bitcoin to a wrong address that wouldn’t count as theft, but it could qualify as a casualty.

CASUALTY A casualty is defined as the loss of property by an identifiable event that is sudden, unexpected, or unusual. In addition to meeting the sudden, unexpected, and unusual tests, Pub 547 also addresses what factors must be proven to support the deduction of a casualty loss.

The guidance lists a bunch of deductible losses and some exceptions which are non-deductible, but few of them seem to be relevant to the kinds of situations most Bitcoiners are likely to face. If access to your private keys is cut off because a computer was destroyed due to fire, flood, earthquake, etc, that would seem to qualify as a casualty loss, as would the computer storing the keys. Also of note is that progressive deterioration and your own negligence would probably disallow you from claiming a casualty loss, so make sure to make backups, especially if the computer/phone running your wallet software is getting old or prone to data loss. This probably also means simply misplacing your private keys, or writing down a brain wallet incorrectly wouldn’t qualify for a casualty loss, though I’m not very confident of this interpretation and would love if someone with more expertise would clarify this point.

LOSS ON DEPOSITS Finally, according to the guidance, a loss on deposits occurs when a bank, credit union, or other financial institution becomes insolvent or bankrupt. One question is what would officially constitute a ‘financial institution’. I’m not sure about funds stored with non-financial services or apps like ChangeTip or Purse.IO, but it would make sense that Bitcoin exchanges would qualify.

If you lose deposited funds, you can elect to treat the loss in one of three ways: as an ordinary loss, a casualty loss, or a nonbusiness bad debt. The rules get a bit complicated here, but my reading is that a nonbusiness bad debt may only be claimed if and when the amount lost is actually known and officially determined; whereas, a casualty or ordinary loss may be elected based on estimates and before an official determination is made. Because of this distinction I think a nonbusiness bad debt cannot be claimed until a customer knows what, if any, amount of a bankrupt institution’s funds will be liquidated to cover the customer’s deposit losses. Sorry Mt. Gox creditors, you may have to wait a while if you want to elect this option.

The guidance also specifies where to report the loss of deposit based on what type of loss is elected. Ordinary losses go on Schedule A, line 23 and are subject to floor and ceiling limits. Also of note is an ordinary loss cannot be elected if the deposit is federally insured (e.g. FDIC). Casualty losses, also subject to limitations, are reported on Form 4684 and Schedule A, and nonbusiness bad debts go on Form 8949 and Schedule D.

So that’s basically my reading of IRS guidance as it relates to the deductibility of Bitcoin losses. Again, I’m not an expert or a tax professional, but I’m interested to hear your comments, corrections, and input. Feel free to check me out on Twitter. Thanks!