Newswise — The risk in crypto investing resurfaced prominently last month, related to former Celsius Network CEO Alex Mashinsky’s arrest on criminal and civil charges stemming from his activity with the now bankrupt cryptocurrency lending platform.

“Investors of cryptocurrency inside the Celsius Network took a big bath last summer when the giant crypto investment company declared bankruptcy,” says Samuel Handwerger, CPA, and accounting lecturer for the University of Maryland’s Robert H. Smith School of Business.

As Mashinsky awaits further legal consequences, what recourse is available for investors suffering losses?

For starters, Handwerger paints a relevant scenario: “Let’s say that in 2021 you had put crypto into the Celsius Network investment company. They hold your crypto and give you a nice return…a promised 17%. Things look too good to be true, and as the old story goes, they are. The company goes bankrupt in the summer of 2022.”

One recourse is claiming personal theft loss in an income tax filing. However, the 2018 Tax Cut and Jobs Act largely eliminated this (until a sunset provision brings it back in 2026) – “but with an exception for Ponzi scheme losses, which applies here,” Handwerger says.

But there’s still a caveat, he says, as “the tax code requires some not-so-easy compliance requirements to determine when you can deduct and how much you can deduct. For example, you cannot deduct the loss until all legal channels of recovery have been exhausted. That can often take a long time…a very long time.”

Fortunately, he adds, “a ‘safe harbor’ method endorsed by the IRS makes compliance easier and allows for tax loss recognition to happen at a time juxtaposed to the uncovering of the Ponzi scheme.”

Handwerger, faculty advisor for both TerpTax and Justice for Fraud Victims (JFV) – a pair of Smith-based, pro bono initiatives available to individuals in the surrounding local communities, details how the safe harbor provision is applicable: “For tax filing, the safe harbor must be based on an investment made for profit/income where a ‘lead-figure’ (like Mashinksy) related to that investment has been charged with fraud or embezzlement. Having met these requirements the provision allows for a current deduction in that year of indictment, allowing you to deduct 95% of your investment loss if you are not seeking third party recovery or 75% if you are seeking such recovery.”

He continues: “While the percentages are the limits for taking the deduction in the same year of the applicable indictment, you can take the rest in a future year, if it becomes legally clear that your real loss was actually greater than the 95% or 75% claimed in the year you claimed the safe harbor.”

Handwerger also notes that safe harbor loss is an itemized deduction and requires the taxpayer to agree not to amend prior tax returns that may have recognized income from the investment and paid tax on such “reported” income.

He concludes: “Safe harbor ultimately recognizes for taxpayers that Ponzi schemes are notorious for insignificant recovery for investors, so having to wait to take the loss for tax purposes is an undue burden, but if the loss recognized by the safe harbor is later recovered, then those amounts would be subject to tax in the year of recovery.”

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