The outcome of SBF’s prosecution could determine how the IRS treats your FTX losses

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FTX founder Sam Bankman-Fried has received Official criminal charges After the collapse of his cryptocurrency exchange, this is more than a moral victory for the exchange’s roughly 1 million individual investors. Although not yet locked in, these investors appear to be on track to take a more favorable tax position as the fate of SBF continues to unfold.

What types of losses can FTX investors claim on their taxes?

Earlier this fall, it appeared that assets lost in the FTX collapse would be treated as capital losses under the United States tax code for the 2022 tax year. This capital loss can be used to offset capital gains. But most investors won’t see compensating capital gains in 2022, a year in which the crypto market took a complete hit.

A capital loss can also be used to offset “ordinary income” such as money earned from a business or job — up to $3,000 per year. Losses are carried forward indefinitely, but if your loss on FTX collapse is substantial, it may take some time to recover it all.

Related: Biden is hiring 87,000 new IRS agents — and they’re coming for you

The most favorable situation for many investors is to claim a theft-loss deduction, which covers ordinary income without any limitation. Claiming a theft loss is usually a very difficult task and may come under scrutiny from the Internal Revenue Service. But the tax code for theft losses contains a “safe harbor” for Ponzi schemes. Often, if an investor can prove a loss in a Ponzi scheme, the IRS does not require additional documentation.

Is FTX a ponzi scheme?

It seems likely that the IRS will eventually view FTX as a Ponzi scheme because investor assets were illegally transferred to SBF’s hedge fund, Alameda Research. To invoke the safe harbor, FTX or its “front” SBF line must be charged with fraud that fits this description. Guidance:

“A specific fraudulent arrangement is an arrangement in which a party (a front person) receives money or property from investors; intends to generate income for the investors; reports income amounts to fictitious investors in part or in whole; pays the intended income or principal, if any, to certain investors from amounts invested by other investors in the fraudulent arrangement. ; and owns some or all of the investors’ money or property.

The charges leveled by the SEC against SBF focus on equity investors, not retail investors. But the SEC specifically noted “the undisclosed diversion of FTX clients’ funds to Alameda Research.” While there isn’t an official green light for Safe Harbor, it’s very close — closer than we expect in 2022.

Outside of criminal charges, the Ponzi scheme also operates a safe harbor with criminal complaint and confession. Although he was very vocal following the FTX collapse, SBF delivered He wasn’t planning on admitting anything.

What should FTX investors and their tax professionals do?

With the personal tax filing deadline of April 18, 2023, investors who lost assets in FTX have some time to see how it plays out. It seems very likely that the SEC will bring additional charges against SBF or FTX.

The IRS may weigh whether existing rates are sufficient to trigger the safe harbor, and 2022 is the year to take it. The theft loss can still be claimed in a future year, but most FTX investors will be eager to offset some of their losses by recouping the income early on their taxes.

Related: Before ETH drops further, reserve some cash for surprise lines

For investors who lost assets in FTX, it would be unwise to claim capital loss at this stage. By some miracle, even if the investor has capital gains to offset from 2022, the tax rate on ordinary income will be much higher. This only makes sense if a person has no ordinary income but capital gains in 2022.

basis for comparison

It is important to note that in both of these situations – capital loss or Ponzi scheme safe harbor – the amount of allowable loss is based on the value of the asset. If the value you were able to extract from the FTX following a decline is zero, you may receive the full amount you originally paid for the property.

From the IRS’s point of view, your theft loss is not only based on the total cost you paid — you also get a kicker for the income you paid. If you traded on the exchange or received income and recognized income for these on a previous tax return, you count these in determining the cost basis if you did not withdraw from the exchange before the decline. This is where your CPA and/or currency trading software will come in handy.

For some investors, when FTX goes down in flames the basis will be more than the asset is worth – maybe even a little more. That might be a silver lining here. While it looks like investors will have to wait until 2023 to see if charges are brought in the matter, the SEC appears to have given them an early Christmas present.

Justin Wilcox Partner at Fiontella, Milone & Lazzaracina, a Connecticut accounting and consulting firm. He founded the firm’s cryptocurrency practice in 2018, providing tax and advisory services to Web3 companies and crypto investors. He mines and trades cryptocurrencies.

This article is for general informational purposes and should not be construed as legal or investment advice. The views, opinions and opinions expressed herein are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.


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