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Tax Implications of Stolen Cryptocurrency or NFT – An Analysis by a Toronto Tax Lawyer – Tax

Canada: Tax Implications of Stolen Cryptocurrency or NFT – An Analysis by a Toronto Tax Lawyer

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

Recently, an American couple was arrested for stealing $3.6 billion worth of cryptocurrency from 2016 by hacking into a cryptocurrency exchange. This news showed that although blockchain and cryptocurrency are considered by many to be 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 totaled $7.8 billion in cryptocurrency.

There have even been instances where the real identity of the cryptocurrency holder has been discovered by an infamous criminal and the cryptocurrency holder would be robbed at gunpoint.

In this article, we will discuss the Canadian tax implications of losing cryptocurrency due to theft, fraud, embezzlement, or robbery.

Income Tax Law Characterization of Cryptocurrency

Cryptocurrency can be characterized as generating business income through an actual business or venture of a commercial nature or fixed assets generating capital gains. While no case law directly addresses the characterization of cryptocurrency profits as capital gains or income, much of the existing case law on income versus capital gains may still apply. Please see our article here for a detailed breakdown of the law regarding capital gains versus income for cryptocurrency.

Capital property involuntarily disposed of

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

However, if the taxpayer in the above situation has not received the actual proceeds and compensation for their involuntarily disposed property, a capital loss will result, as discussed below.

What is a replacement property

the income tax law defines replacement property as property for which it must be reasonable to conclude that the property was acquired by the taxpayer to replace the former property and that the replacement property was used for a similar purpose to the former property. In the case of cryptocurrency, the replacement asset can be broadly generalized as any investment instrument that can achieve the goal of generating business income.

Where the replacement property has been purchased within 2 years, the taxpayer may only pay tax to the extent that the proceeds of involuntary disposition exceed the adjusted cost base of the replacement property.

Capital loss where the involuntary loss has not been compensated

Where the Taxpayer has received no compensation for his capital loss as a result of 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 retrospectively for 3 years.

Stolen inventory

On the other hand, inventory, including cryptocurrency, that has been lost through theft, fraud, embezzlement or robbery may be deducted as business losses in accordance with the general principle of deducting business expenses alongside the limitations listed in subsection 18(1)(a) of the Income Tax Act. However, for the general principle to apply, the taxpayer must show that:

  • these losses constitute a risk inherent in the operation of the business;

  • and the loss is reasonably incidental to the normal revenue-generating activities of the business.

Many complex and new questions must be asked and answered in order to apply the general principle of inventory loss deduction to cryptocurrency traders. Further, these would likely vary on a case-by-case basis depending on the merchant’s behaviors and strategies as well as how the merchant’s cryptocurrency inventory was lost through theft, fraud, embezzlement, or robbery. . It is best to consult with an experienced Canadian crypto tax attorney to answer your questions about specific details if you have lost cryptocurrency due to theft, fraud, embezzlement, or of a robbery.

Any insurance payments or other forms of compensation for inventory lost through theft, fraud, embezzlement or robbery would be included in business income.

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

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

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.