Victim of Cryptocurrency Scams Marketed as “Investments”? There May be Income Tax Deductions from CRA – Guidance from a Canadian Crypto-Tax Lawyer

Did You Get Caught in a Cryptocurrency Fraud?

Everything’s bigger in the USA. Crypto fraud is no different, it seems. After getting caught for causing over $1 billion in investor funds to vanish, the disgraced US crypto exchange FTX made Canadian crypto firm QuadrigaCX look like an underachiever. When all was said and done, QuadrigaCX managed to misplace only about $170 million.

But FTX and QuadrigaCX represent only the headline-making cases of cryptocurrency-based investor fraud. Canadian and US anti-fraud groups and consumer watchdogs post almost daily alerts about crypto scams aiming to defraud investors and our crypto tax-law practice regularly advises clients who have been victims of crypto fraud.

Although their money might unfortunately never be recovered, Canadian cryptocurrency investors who fall victim to crypto fraud may be able to deduct the loss for income-tax purposes.

This article discusses two potential options for doing so: (1) claiming a capital loss relating to stolen cryptocurrency investments and (2) claiming a bad-debt election under paragraph 50(1)(a) of Canada’s Income Tax Act. After discussing these two crypto-tax deduction options, this article concludes by offering pro crypto tax tips from our top certified specialist in taxation Canadian cryptocurrency tax lawyers to Canadian cryptocurrency traders and investors.

Canadian Income-Tax Deductions for Canadian Cryptocurrency Investors Who Fall Victim to Crypto Fraud or Crypto Scams

This article examines two potential options for Canadian cryptocurrency investors who fall victim to fraud. The first option involves claiming a capital loss relating to stolen cryptocurrency investments. The second option relies on the bad-debt election under paragraph 50(1)(a) of Canada’s Income Tax Act.

As a preliminary matter, we should clarify that Canada’s Income Tax Act generally doesn’t permit a taxpayer to claim a personal expense as a deduction for income-tax purposes. Crypto-scam deductions generally apply only if the loss occurred while the victim was pursuing what the victim believed to be a genuine investment or income-earning endeavour.

As a result, if you fell victim to a crypto scam or crypto theft while pursuing a personal endeavor—e.g., using crypto to buy consumer goods for personal use, transferring crypto to someone you met on an online-dating app, making crypto payments to hackers to release ransomware on your personal computer, etc.—you cannot claim a deduction.

Reporting Stolen Cryptocurrency Investments as a Capital Loss

The first option for a Canadian cryptocurrency investor is to claim a capital loss relating to the stolen cryptocurrency. This option makes the most sense in situations where, for example, a fraudulent crypto-investment platform asks the Canadian crypto investor to transfer cryptocurrency into the platform’s wallet under the guise that the investor’s portfolio will be invested, and the fraudsters then simply steal the cryptocurrency by transferring it to their own wallets.  

A “disposition” of a “property” triggers a tax event for the Canadian taxpayer who disposed of that property.  Canada’s Income Tax Act gives a broad definition of the word “property,” which includes intangible personal property, such as cryptocurrency. The Income Tax Act’s definition of “disposition” is also quite broad. Basically, a “disposition” occurs whenever a person relinquishes all aspects of property ownership (e.g., possession, control, etc.)—regardless of whether the person does so voluntarily or involuntarily, and regardless of whether the person receives compensation.

Thus, the theft of the investor’s cryptocurrency qualifies as a “disposition” under Canada’s Income Tax Act. Moreover, it was a disposition for which the investor received nil proceeds. As a result, the investor may claim an allowable capital loss equal to 50% of the investor’s cost for the cryptocurrency that the investor transferred to the fraudulent platform. 

Making the Bad-Debt Election for Theft of Crypto-Investment Funds

The second option for a defrauded Canadian cryptocurrency investor is to make a bad-debt election under paragraph 50(1)(a) of Canada’s Income Tax Act.  This election permits a creditor to claim a capital loss on an uncollectible debt.  

Suppose, for example, that a Canadian cryptocurrency investor held crypto assets with FTX, QuadrigaCX, or another cryptocurrency exchange that ultimately went bankrupt. As part of the bankruptcy process, the Canadian cryptocurrency investor files with the exchange’s bankruptcy trustee a proof of claim detailing the amount that the exchange owes to her—i.e., assets that the investor held with the now bankrupt cryptocurrency exchange.

The Canadian cryptocurrency investor has therefore become one of the exchange’s creditors. The crypto exchange owes the investor a debt that equals the value of the cryptocurrency that she held in her account with the crypto exchange.  

If that debt later becomes uncollectable (for instance, the bankruptcy trustee confirms that the investor won’t get anything under the bankruptcy process), the investor can elect under paragraph 50(1)(a), which deems her to have disposed of the debt for nil proceeds. As a result, the investor may now claim an allowable capital loss equal to 50% of her adjusted cost base for the lost cryptocurrency.

Pro Tax Tips: Deducting Crypto-Investment Losses on Income Account, Audit Risk & Record-keeping Requirements

The two options that we examined in this article assume that the Canadian investor’s crypto-scam losses will qualify for capital treatment, which means that the investor’s loss is 50% deductible as an allowable capital loss.

In certain circumstances, however, the resulting loss may be a fully deductible business loss (as opposed to a half-deductible capital loss). Canada’s Income Tax Act sets out two entirely different tax regimes for business income and business losses, on the one hand, and for capital gains and capital losses, on the other.

A taxpayer’s intent at the time of acquiring the cryptocurrency is the most important criterion that the Tax Court of Canada and the Canada Revenue Agency will consider when determining whether the transaction produced a capital gain or business income. Yet to discern a taxpayer’s intention, the courts and the CRA will focus on the objective factors surrounding both the acquisition and the disposition of the cryptocurrency.

For more information on distinguishing between capital gains and business income in the context of cryptocurrency transactions, please read our “Tax Guide for Crypto & Bitcoin Businesses: Computing Inventory Costs” and contact one of our top Canadian crypto-tax lawyers for a detailed tax opinion specifying how you should deduct your cryptocurrency fraud losses.

Regardless of which option you choose, the CRA may audit the Canadian cryptocurrency investor’s claim—especially if the loss is sizeable. A taxpayer who lacks proper records will be at the CRA’s mercy during a Canadian cryptocurrency tax audit.

Cryptocurrency investors must maintain records of all their cryptocurrency transactions. In particular, you should maintain the following records about your cryptocurrency transactions:

• The date of each transaction;
• The transaction ID (i.e., TxID or Tx Hash);
• Any receipts for purchasing or transferring cryptocurrency;
• The value of the cryptocurrency in Canadian dollars at the time of the transaction;
• The digital-wallet records and cryptocurrency addresses;
• A description of the transaction and of the other party (e.g., the other party’s cryptocurrency address);
• The exchange records;
• Records relating to any accounting and legal costs; and
• Records relating to any software costs for managing your tax affairs.

You should also maintain a copy of any formal legal opinions that you received from your top Canadian crypto-tax lawyer. For instance, our expert Canadian crypto-tax lawyers can prepare a tax memorandum examining whether your cryptocurrency losses may be reported as capital losses, as business losses, or as a blend of both. This confidential and privileged document can prove invaluable by ensuring that the CRA doesn’t fault you for misrepresenting the information on your tax returns.

If you use a cryptocurrency exchange, you should periodically export your transaction information to avoid losing it. Ideally, you should also use offsite or cloud storage to back up your documents and computer files. When QuadrigaCX went bankrupt and turned out to be nothing more than a Ponzi scheme, many Canadians lost all their cryptocurrency-transaction records, which made claiming a tax loss that much more difficult.

In addition, if you discover that you’ve been defrauded by what you initially believed to be a legitimate cryptocurrency investment, you should gather as much information as possible to show that the enterprise purported itself to be a legitimate investment and to evidence the amount that you lost.

These records might include bank-account statements or cryptocurrency-exchange statements showing what you transferred to the illegitimate enterprise, wire-transfer records, screenshots of your account with the fraudulent platform, emails or screenshots of communications with the individuals behind the fraudulent platform, and police reports.

You should also consider hiring a private investigator to prepare a forensic blockchain-tracing analysis showing that the crypto scammers transferred your crypto assets to unauthorized wallets.

Proper supporting documents and recordkeeping should convince a CRA tax auditor to allow your crypto-loss claim. But if you run into an especially unreasonable tax auditor, speak to one of our top Canadian crypto-tax lawyers, who can represent you during your crypto-tax audit.  

Frequently Asked Questions

Question: I understand that, in some circumstances, Canadian taxpayers can deduct their cryptocurrency losses for income-tax purposes. My personal computer was attacked by ransomware, and I ended up paying the hackers in cryptocurrency. Can I claim my lost cryptocurrency as a deduction on my Canadian income-tax return?

Answer: No.Canada’s Income Tax Act generally doesn’t permit a taxpayer to claim a personal expense as a deduction for income-tax purposes. Crypto-scam deductions generally apply only if the loss occurred while the victim was pursuing what the victim believed to be a genuine investment or income-earning endeavour. As a result, if you fell victim to a crypto scam or crypto theft while pursuing a personal endeavor—for example, making crypto payments to hackers to release ransomware on your personal computer—you cannot claim a deduction.

Question: I’m a Canadian cryptocurrency investor, and I was defrauded while pursuing what I believed to be a genuine cryptocurrency investment. Can I deduct the resulting loss for income-tax purposes?

Answer: You might be able to claim a deduction. If so, the type and extent of the deduction depends on your exact circumstances. Say, for example, that a fraudulent crypto-investment platform simply made off with your cryptocurrency. The theft of your cryptocurrency constitutes a “disposition” for which you received no proceeds. As a result, you may claim an allowable capital loss equal to 50% of your cost for the cryptocurrency that you transferred to the fraudulent platform. In certain circumstances, however, the resulting loss may be a fully deductible business loss (as opposed to a half-deductible capital loss). For advice about your options, contact one of our top Canadian crypto-tax lawyers today.  

Question: I’ve been defrauded by what I initially believed was a legitimate cryptocurrency investment. What records should I retain if I intend to claim that loss?  

Answer: Cryptocurrency investors should maintain records of all their cryptocurrency transactions—not just those relating to their losses. In particular, you should maintain the following records about your cryptocurrency transactions:

• The date of each transaction;
• The transaction ID (i.e., TxID or Tx Hash);
• Any receipts for purchasing or transferring cryptocurrency;
• The value of the cryptocurrency in Canadian dollars at the time of the transaction;
• The digital-wallet records and cryptocurrency addresses;
• A description of the transaction and of the other party (e.g., the other party’s cryptocurrency address);
• The exchange records;
• Records relating to any accounting and legal costs; and
• Records relating to any software costs for managing your tax affairs.

You should also maintain a copy of any formal legal opinions that you received from your top Canadian crypto-tax lawyer. For instance, our expert Canadian crypto-tax lawyers can prepare a tax memorandum examining whether your cryptocurrency losses may be reported as capital losses, as business losses, or as a blend of both. This confidential and privileged document can prove invaluable by ensuring that the CRA doesn’t fault you for misrepresenting the information in your tax returns.

If you use a cryptocurrency exchange, you should periodically export your transaction information to avoid losing it. Ideally, you should also use offsite or cloud storage to back up your documents and computer files. When QuadrigaCX went bankrupt and turned out to be nothing more than a Ponzi scheme, many Canadians lost all their cryptocurrency-transaction records.

In addition, if you discover that you’ve been defrauded by what you initially believed to be a legitimate cryptocurrency investment, you should gather as much information as possible to show that the enterprise purported itself to be a legitimate investment and to evidence the amount that you lost. These records might include bank-account statements or cryptocurrency-exchange statements showing what you transferred to the illegitimate enterprise, wire-transfer records, screenshots of your account with the fraudulent platform, emails or screenshots of communications with the individuals behind the fraudulent platform, and police reports. You should also consider hiring a private investigator to prepare a forensic blockchain-tracing analysis showing that the crypto scammers transferred your crypto assets to unauthorized wallets.

Proper supporting documents and recordkeeping should convince a CRA tax auditor to allow your crypto-loss claim. But if you run into an especially unreasonable auditor, schedule a confidential and privileged consultation with one of our expert Canadian crypto-tax lawyers today.

DISCLAIMER: This article provides only general information and contains no legal advice. This article is current only as of the publishing date. It will not be updated, so it may no longer be relevant on the day that you read it. This article is not a substitute for legal advice. Each tax circumstance is unique to its facts and may not qualify for any perceived remedy described in this article. You should contact a Canadian tax lawyer if you have specific legal inquiries.