FTX, Celsius, and Crypto Exchange Bankruptcies: How to Handle the Tax Treatment

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, personal theft losses, profit-motivated 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.

Four Legal Theories, Four Different Results

Theory 1: Worthless Securities (IRC § 165(g))

Section 165(g)(2) uses a narrow definition of security: corporate stock or stock rights, or certain bonds, debentures, notes, and certificates of indebtedness issued in registered form or with interest coupons. A digital asset does not qualify merely because it was held in an exchange account. A lending or bankruptcy claim may require a separate debt analysis, and a section 165(g) deduction requires the qualifying security to become completely worthless in the year claimed.

Theory 2: Personal Theft Loss (IRC § 165(c)(3))

Section 165(h)(5) permanently limits most personal casualty and theft losses, as amended by the One Big Beautiful Bill Act in July 2025. Beginning in 2026, the exception covers qualifying federally declared and state-declared disasters, along with the limited rule for personal casualty gains. That personal-loss rule is different from a theft loss incurred in a transaction entered into for profit under section 165(c)(2).

Fraud or a criminal conviction does not automatically make an exchange bankruptcy eligible for the Ponzi scheme safe harbor. Revenue Ruling 2009-9 and Revenue Procedure 2009-20 require specific facts, including a qualifying fraudulent investment arrangement and the required discovery-year events. The taxpayer also must address basis and any reasonable prospect of recovery.

Audit risk: Medium-high. The legal theory, applicable state theft law, basis, discovery year, and expected bankruptcy recoveries all need support.

Theory 3: Bad Debt (IRC § 166)

If the customer’s legal relationship with the platform created a bona fide debt, a wholly worthless nonbusiness bad debt may be treated as a short-term capital loss. The account agreement, bankruptcy claim, and recovery rights matter. An exchange deposit should not be labeled a loan without reviewing those documents.

Theory 4: Profit-Motivated Theft Loss (IRC § 165(c)(2))

Section 165(c)(2) is the live theft-loss route when an individual entered the transaction primarily for profit. IRS Chief Counsel Advice 202511015 explains that an investment transaction can satisfy the profit-motive requirement and that a theft loss is generally not sustained while a reasonable prospect of recovery remains. The memorandum addresses scam losses, not FTX or Celsius, and Chief Counsel Advice is not precedent, so it does not decide the treatment of an exchange-bankruptcy claim.

For an exchange failure, the taxpayer still must establish a theft under the law of the applicable state, connect the loss to the profit-motivated transaction, document adjusted basis, and determine when recovery became no longer reasonably possible. An open bankruptcy claim or expected distribution can delay or reduce a deductible loss.

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

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.

Sources reviewed

This article was reviewed against current primary guidance on September 17, 2026. Loss treatment remains fact-specific, and later recoveries can change the result.

• 26 U.S.C. § 165: Losses
• Public Law 119-21, section 70109: Limitation on casualty loss deduction
• IRS Chief Counsel Advice 202511015: Theft losses and transactions entered into for profit
• IRS Publication 547: Casualties, Disasters, and Thefts
• IRS Publication 550: Investment Income and Expenses
• Revenue Ruling 2009-9: Theft loss from a fraudulent investment arrangement
• Revenue Procedure 2009-20: Optional safe harbor for qualifying fraudulent arrangements

A practical next step

Crypto tax software can help organize transactions and recoveries, but it cannot decide the legal character or timing of a bankruptcy loss without the claim documents and final facts. View Koinly.

Affiliate disclosure: Bugaboo Bookkeeping may earn a commission if you sign up through this link, at no additional cost to you. The relationship does not change our evaluation of the tool.

See our nationwide crypto tax reconciliation services and free crypto transaction log.

Common questions

Is a frozen crypto exchange balance an automatic tax loss?

No. Loss treatment depends on the taxpayer’s property rights, the bankruptcy claim, recoveries, and the event that finally establishes the loss or disposition.

How should I track bankruptcy recoveries?

Preserve the original asset basis, claim records, court notices, and each cash or token recovery. Keep unresolved amounts separate until the tax treatment is supportable.

Can a tax form replace the bankruptcy records?

No. Any tax form should be reconciled to the transaction ledger, basis records, claim documents, and actual recoveries.