Tax Guide: Recovered Cryptocurrency After Bankruptcy

This article follows up on our previous discussion regarding the tax implications of bankruptcies like FTX and Celsius. As you might recall, IRD’s position is that investors wouldn’t be able to claim losses on inaccessible crypto funds until bankruptcy proceedings were finalized.

Now that the proceedings for Celsius and other exchanges have concluded, some investors have recovered a portion of their locked crypto. This raises the question:

How do you account for recovered currency?

Understanding Your Loss Calculation:

Let’s use an example to illustrate the process:

• In 2021: Jim purchased 1 Bitcoin (BTC) for $50,000 NZD and deposited it on the XYZ exchange.

• March 1, 2023: XYZ exchange halted withdrawals, essentially locking Jim’s funds.

• September 30, 2023: XYZ’s bankruptcy proceedings were finalized, and Jim received 0.1 BTC back.

Key Points to Consider:

• Claiming Losses: Since the bankruptcy proceedings concluded after March 31, 2023 (the end of the NZ tax year), Jim can’t claim losses for the locked crypto in his 2023 tax return.

• Calculating Net Loss: Jim’s net loss from the bankruptcy is the difference between the original cost and the recovered portion. He initially invested $50,000 for 1 BTC, but only received 0.1 BTC back. Therefore, his net loss is 0.9 BTC (1 BTC – 0.1 BTC recovered).

• Claiming Deductible Loss: Using the original cost basis of $50,000, Jim can claim a deductible loss of $45,000 (0.9 BTC x $50,000) in his 2024 tax return.

• Remaining Crypto Asset: Moving forward, Jim holds onto the remaining 0.1 BTC, but with a revised cost basis of $5,000. This adjusted cost basis will be used if he decides to sell BTC in the future (i.e., future profit = future sale price less cost value of $5,000).

While recovering some crypto assets from bankruptcy can be a relief, the tax implications require careful consideration. By understanding how to calculate your net loss and adjust your cost basis for remaining crypto, you can ensure accurate tax reporting.