The Core Tax Question: When Is a Loss Actually a Loss?
For FTX, Celsius, BlockFi, Voyager, and similar bankruptcies, the threshold question is: when do you get to recognize the loss? The IRS has not issued specific guidance on crypto exchange bankruptcies, so practitioners apply existing tax law — specifically the rules governing worthless securities, theft losses, and bad debts.
The answer depends on which theory applies to your situation — and that depends on what you had on the platform (securities vs. loans vs. custody assets) and when you’re filing.
Three Legal Theories, Three Different Results
Theory 1: Worthless Securities (IRC § 165(g))
If your crypto was held in an account structured as a security, you can claim a capital loss in the year the security becomes worthless. The challenge: most crypto held on centralized exchanges is not a security — it’s either a loan to the platform or held in custody. The exception may apply to equity tokens or certain lending products.
Theory 2: Theft Loss (IRC § 165(c)(3), Rev. Rul. 2009-9)
If the exchange’s collapse involved fraud — and FTX clearly did — you may qualify for a theft loss under IRC § 165(c)(3). However, the Tax Cuts and Jobs Act of 2017 suspended most personal theft losses through 2025. The exception is Ponzi scheme losses under Rev. Rul. 2009-9 and Rev. Proc. 2009-20, which remain deductible as ordinary losses.
Whether FTX qualifies as a Ponzi scheme for this purpose is a factual and legal question. There is significant practitioner consensus that it does, given the findings in the criminal case. This is an area where you want your CPA to make a documented, defensible determination — not an assumption.
Audit risk: High. Theft loss claims — especially large ones — draw IRS scrutiny. Documentation is critical.
Theory 3: Bad Debt (IRC § 166)
If your crypto was loaned to the platform (which is how most exchange deposits are legally structured), the loss may be treated as a bad debt — specifically a non-business bad debt, which results in a short-term capital loss, deductible only against capital gains plus $3,000/year.
What About Bankruptcy Distributions?
When you receive a distribution from a bankruptcy estate, you have a realization event. The amount distributed is treated as proceeds. Your cost basis is what you paid for the assets originally (or what you reported as income if you received them through staking, mining, etc.).
Example: You had 1 ETH on Celsius, cost basis $2,000. Celsius distributes assets worth $800 equivalent.
- Proceeds: $800
- Basis: $2,000
- Capital loss: $1,200 (character depends on holding period)
If you already claimed a loss in a prior year under a theft loss or worthlessness theory, and you then receive a distribution, you may have to recognize income on the recovery. This is the “tax benefit rule” under IRC § 111.
Year-by-Year Timing: What to Do When
| Event | Year to Recognize | Treatment |
|---|---|---|
| Platform freezes withdrawals | Not yet — still open question | No loss recognized until determinable |
| Platform files bankruptcy | Potentially — depends on theory | Document everything; consult CPA |
| You receive a distribution | Year of distribution | Proceeds of sale; recognize gain/loss |
| Claim is fully settled (or abandoned) | Year of settlement | Remaining loss recognized |
Documentation: What the IRS Will Want to See
If you’re claiming any kind of loss related to a crypto exchange failure, document:
- Account statements showing your balance at the time of freeze/bankruptcy
- Cost basis records for the assets (purchase dates, prices paid)
- Your claim filed with the bankruptcy court (if applicable)
- Any distributions received and their reported value
- The legal theory your CPA used and why it applies to your situation
This documentation needs to survive an IRS examination. “I lost money on FTX” is not a defensible tax position. The theory, the calculation, and the records all matter.
In Koinly / CoinTracker: How to Record This
Most crypto tax software doesn’t handle bankruptcy scenarios cleanly. The most common approach:
- Mark the frozen assets as a “lost” or “stolen” transaction at the date of the triggering event
- When you receive a distribution, import it as a separate acquisition at the distribution value
- Reconcile the net gain/loss manually if the software doesn’t support bankruptcy workflows natively
We’ve processed FTX, Celsius, BlockFi, and Voyager scenarios across Koinly, CoinTracker, CoinLedger, and ZenLedger. The workflows differ and the default handling in most platforms is wrong — it needs to be overridden manually.