AUTHOR’S NOTE: It has been suggested to me that this article may be premature, given the developing nature of the Mt. Gox situation. However, I wanted to go ahead and put it out for US taxpayers for two reasons. First, how you proceed with your recovery efforts will have an impact on what kind of loss you can claim in 2014 and later. Second, certain regulatory filings that you may be required to submit will be due long before Gox is settled. I will provide updates to the suggestions here as appropriate and I am always willing to answer questions via email.
Mt. Gox is out of action, probably for good. Its parent company has filed for bankruptcy protection in Japan and the US Attorney for the Southern District of New York has launched a probe into potential criminal conduct by the company and its management. You had coins at Mt. Gox and it looks like you might have lost them forever. Now what do you do?
First, you will need to determine how much you’ve lost. The best way to do this would be with a recent download of your records from Mt. Gox. Though the website was still down as of the date of publication, it is possible that some functionality may be restored in the coming weeks for just this purpose. If this doesn’t happen and if you haven’t kept records independently of your Mt. Gox account, then you may be able to indirectly determine how much you’ve lost using records from your bank or payment processor. An accountant should be able to help you with this. A loss at Mt. Gox would most likely have to be claimed for 2014 or later, so you have plenty of time left to calculate your loss.
Next, you must consider what kind of loss you have suffered, which determines how it can be claimed for income tax purposes. Bitcoins probably won’t be considered securities by the IRS, so worthless securities treatment is not likely to be applicable to this situation. Capital loss treatment may be allowable to the extent that bitcoin losses are not recouped in connection with bankruptcy proceedings. However, in order to claim the loss, there must be no chance of ever recovering your coins. For individuals, capital losses are capped at the amount of a taxpayer’s capital gains for the year or $3,000, whichever is greater. Unused capital losses can be carried forward to future years until exhausted.
Casualty loss treatment may be available to taxpayers as an alternative to capital loss treatment. According to the IRS, “a casualty is the damage, destruction or loss of property resulting from an identifiable event due to some sudden, unusual, or unexpected cause.” Subject to certain qualifications, individuals may elect to deduct losses suffered on deposits in a bankrupt or insolvent financial institution as either a casualty loss, a theft loss, or an ordinary loss. Of the three, ordinary loss treatment is likely to be the most favorable from a tax perspective. However, the IRS may disallow losses claimed in connection with this provision on the grounds that Mt. Gox was not a qualified financial institution under the definition of the Internal Revenue Code.
If Mt. Gox’s management is found to have engaged in improper conduct, then theft loss treatment may be your best option. How the theft was committed, and by whom, determine who can claim the loss. Mt. Gox owes its customers hundreds of millions of dollars worth of bitcoins. That debt will need to be dealt with in liquidation proceedings. If Mt. Gox lacks the assets to make its customers whole because a third party has exploited the exchange, then Mt. Gox has likely suffered a deductible theft loss (not its customers). The company is itself reportedly exploring the possibility of a criminal complaint related to its collapse. On the other hand, if the company’s management has engaged in criminal conduct which either directly or indirectly resulted in the theft of its customers’ assets, then its customers are the ones who are likely to have suffered the loss for which the theft deduction can be claimed.
Casualty and theft losses are subject to a floor of $100 and 10% of the taxpayer’s adjusted gross income. That means that the amount of the loss, minus $100, is deductible to the taxpayer only to the extent that it exceeds 10% of the taxpayer’s adjusted gross income. The deductible loss must also be reduced by the amount of any compensation received in connection with bankruptcy proceedings or a lawsuit. A side note: the IRS has established a safe harbor for deductibility of certain claims for losses on investments stemming from a Madoff-type Ponzi Scheme. Even if Mt. Gox is ultimately discovered to have operated as a fractional reserve for all or part of the period leading up to its failure, this safe harbor will be unavailable to US taxpayers in connection with Mt. Gox losses because bitcoins are not investment securities.
After you have calculated your loss and determined how to deduct it, you should consider the need for additional filings related to your activity at Mt. Gox. While you will likely have to wait until 2015 at the earliest to claim a loss related to the failure of the exchange, you have considerably less time to file a Foreign Bank Account Report or IRS Form 8938 for 2013. A US taxpayer must file IRS Form 8938, “Statement of Specified Foreign Financial Assets,” if, as of the last day of the tax year, he owned or had an interest in foreign financial assets exceeding $50,000 (or $75,000 at any time during the year). The form is due with the taxpayer’s return (not later than April 15, 2014 for 2013 returns). An extension of time to file that is applicable to the taxpayer’s return also applies to this form. The Foreign Bank Account Report must be filed by June 30 by any taxpayer with an interest in a foreign bank account that exceeded $10,000 at any time during the previous year. Given Bitcoin’s substantial gains in 2013, it is likely that many US taxpayers who were customers at exchanges outside the US will need to file this form. Timely filing of the FBAR is mandatory; no extensions are granted.
Regulatory filings are especially important for 2013 because the US government is already in possession of Mt. Gox’s records (or will be soon) in connection with its investigation. Ironically, the Department of Justice may know more about your account than you do. While the focus of the probe is not likely to be the company’s customers per se, it is impossible to predict how the investigation will proceed or whether the records will be shared with other agencies. On a related note, I have been asked by at least one taxpayer whether it would be a good idea to submit an FBAR if you aren’t certain that you exceeded $10,000 in assets, but think you might have. My answer is “probably not.” If you haven’t kept up with your records, then you will have to decide on your own what you should do before the deadline, but here is my $.02: In order to complete the form, you must supply the maximum value for your account during the year. If you’re not certain what the maximum was and also aren’t absolutely certain that you exceeded the reporting threshold, then you may end up hurting yourself in two ways. You will be filing a form that you have reason to know is misstated, perhaps materially so and you may be telling the tax authorities that you had more money last year than you actually did. Either or both of those mistakes could cost you during an audit.
Now may be too early to guess with any degree of accuracy just what will become of Mt. Gox, Mark Karpeles, or what’s left of the missing $500,000,000 in bitcoins. If history is any indication, Bitcoin’s best known exchange isn’t coming back in any form, ever. The goodwill enjoyed by the company, which it painstakingly built up over half a decade as Bitcoin has grown, is now worthless. The very name of the exchange is utterly toxic, as evidenced by the currency of the word “gox” as a verb in the English language. Many Bitcoiners who have just been goxed are likely experiencing the bitterness of a failed investment for the first time in their lives. To those unfortunate people, I would say that nothing can prepare you for the visceral reality of watching the disappearance before your eyes of a real chunk of wealth that you used to own. I would say that, but I know from experience that it wouldn’t make you feel better and would probably just piss you off. Nevertheless, the number of bitcoins in Mt. Gox’s possession isn’t likely to actually be zero, so there may be some hope yet for at least a partial recovery of your money.