Tax Implications Of Stolen Cryptocurrency Or NFT – A Toronto Tax Lawyer Analysis – Tax

Introduction – loss of cryptocurrency or NFT due to theft,
fraud, embezzlement or robbery.

Recently a US couple was arrested for stealing $US3.6 Billion of
cryptocurrency from 2016 by hacking a cryptocurrency exchange. This
news showed that although blockchain and cryptocurrency is
considered by many to be a revolutionary technology, cryptocurrency
can be stolen by sophisticated hackers.

Cryptocurrency or NFTs can also be lost through fraud or
embezzlement. In 2021, cryptocurrency losses from scams totalled
$US7.8 billion worth of cryptocurrency.

There were even instances that cryptocurrency’s holder’s
real-life identity was discovered by nefarious criminal and the
cryptocurrency holder would be robbed at gun point. https://www.fastcompany.com/40509102/1-8-million-worth-of-cryptocurrency-stolen-at-gunpoint

In this article, we will address the Canadian tax implication of
lost cryptocurrency due to theft, fraud, embezzlement, or
robbery.

Income Tax Act Characterization of Cryptocurrency

Cryptocurrency may be characterized as either generating business income through an actual
business or an adventure in the nature of trade or capital
properties generating capital gains. While there has been no case
law that directly deals with the characterization of cryptocurrency
profit as capital gains or income, much of the existing case law on
the income vs capital gains can still apply. Please see our article
here for a detailed breakdown on the law
regarding capital gains vs income for Cryptocurrency.

Involuntarily Disposed Capital Property

When a taxpayer received compensation for his or her lost
capital property in the form of either direct compensation from the
party responsible for the theft, fraud, embezzlement or robbery, or
received compensation from an insurance company, the Income Tax Act
deems there to be an involuntarily disposition of the
taxpayer’s former property. Subsections 13(4) and 44(1) of the
Income Tax Act operates to defer this deemed disposition for two
years if replacement property is acquired within two years.

However, if the taxpayer in the above situation did not receive
actual proceeds and compensations for his or her involuntarily
disposed property, a capital loss will result, as we will discuss
below.

What is Replacement Property

The Income Tax Act defines replacement property as
properties where it must be reasonable to conclude that the
property was acquired by the taxpayer to replace the former
property whereby the replacement property was used for a similar
purpose as the former property. In the case of cryptocurrency, the
replacement property may be generalized widely as any investment
instrument that can carry out the purpose of generating business
income.

When the replacement property was purchased within 2 years, the
taxpayer may only pay tax to the extend the proceed of the
involuntary disposition exceed the adjusted cost base of the
replacement property.

Capital Loss when The Involuntary Loss Was not Compensated

When the Taxpayer did not receive any compensation for his or
her capital property loss through theft, fraud,
embezzlement or robbery, the taxpayer may claim a capital loss
under section 40 of the Income Tax Act. This capital loss
can be carried forward indefinitely or carried back 3 years

Stolen Inventory

On the other hand, inventories, including Cryptocurrency, that
were lost through theft, fraud, embezzlement or robbery can be
deducted as business losses according to the general principle of
deduction for business expenses alongside with the enumerated
limitations contained in paragraph 18(1)(a) of the Income Tax
Act. However, for the general principle to apply, the taxpayer
must demonstrate that:

• such losses are an inherent risk of carrying on the
  business;




• and the loss is reasonably incidental to the normal
  income-earning activities of the business.

Many complex and novel questions need to be posed and answered
in order to apply the general principle of deducting inventory
losses to cryptocurrency traders. Furthermore, these would likely
vary on a case-to-case basis based on the behaviors and strategies
of the trader as well as how the trader’s cryptocurrency
inventory came to be lost via theft, fraud, embezzlement or
robbery. It is best to consult an experienced Canadian crypto tax
lawyer to answer your questions about the specific details if you
lost cryptocurrency due to theft, fraud, embezzlement or
robbery.

Any insurance payout or other forms of compensation for
inventory lost to theft, fraud, embezzlement or robbery would be
included as business income.

Pro Tax Tip – Keep Records and Books on Your Cryptocurrency
Transactions

Theft, fraud, embezzlement or robbery of cryptocurrency asset is
a constant risk facing all cryptocurrency holders. It is important
to keep good records of your past cryptocurrency transactions and
consult with experienced Toronto crypto tax lawyers to see how your
losses can be deducted to minimize unnecessary tax consequences in
an already stressful and unfortunate situation.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.