Cold Card Hack - The Tax Implications
This is a high level commentary / tax assessment for the Bitcoin community affected by the recent Cold Card wallet attack. I am a Chartered Professional Accountant registered in Ontario, Canada. The contents of this article are an assessment of the situation for Canadians and Americans affected. This is for informational and education purposes only. Consult with your personal tax professional on your specific situation.
As a fellow “Bitcoiner” I want to extend my thoughts to those in the community who were recently affected by the recent Cold Card bug affecting and draining wallets of users who otherwise thought there funds were safe.
The Heist
For those out of the know, at time of writing, over 1,100 Bitcoin have been stolen from hundreds of Cold Card hardware wallets and more will be stolen in the coming days and weeks. The root cause of the theft was due to firmware a bug in the code of Cold Card hardware wallets that reduced the complexity of the security features used to protect users of the Bitcoin network.
In short the Bitcoin network is fine, however one specific vendor’s design to secure users within the network using its devices was not. You can learn more about it in the video link below.
The Tax Fallout
For the Canadians and Americans affected by the theft an after thought you may have is “how does this affect my taxes?” As a professional accountant I’ve gone ahead to perform that assessment of the situation so it’s on your radar.
Note that this assessment was done at the Federal levels for both Canada and the US. The State, Provincial and Territorial tax codes are not considered as part of this assessment. You should discuss your specific situation with your personal tax accountant.
The high level assessment for Canadians and Americans affected is that based on the current structure of each countries respective tax codes you will not be expected to owe taxes on the theft of stolen property. The reason this is the case, is because no such trade, exchange or other consideration was made in the transaction (i.e. theft) of your property, which Bitcoin is classified as under both countries tax codes. In other words no realization resulting in taxation happened as you didn’t receive cash or other economic benefit for the disposition of your property.
For the Canadians
For the Canadians affected, your taxable obligations are $0 under the Income Tax Act Section 54 “‘proceeds of disposition’ of property includes (a) the sale price of property that has been sold, (b) compensation for property unlawfully taken, (c) compensation for property destroyed and any amount payable under a policy of insurance…”
As a Canadian you actually have an added benefit to apply the adjusted cost basis of the funds stolen. For example, if 50,000 CAD of Bitcoin was stolen from you at an adjusted cost basis of 10,000 CAD, you are allowed under the Income Tax Act to record a Capital Loss on your personal tax return. Under Section 40 capital losses emerge when the proceeds of disposition ($0) are less than the adjusted cost basis ($10,000).
50% of these losses are considered allowable which is generally in line with the Canadian tax code of 50% inclusion for taxable capital gains.
Capital losses can be applied retroactively up to the preceding 3 tax years in which the loss occurred to offset previous taxable capital gains. Capital losses may be carried forward against taxable capital gains occurring in future tax years indefinitely.
A word of caution for Canadians considering claiming a Capital Loss. To claim the Capital Loss with zero proceeds of disposition to the Canada Revenue Agency (CRA) you must be able to definitively prove the theft on chain and the cost basis associated with it.
For the Americans
Similar to your neighbours you should not have a taxable obligation resulting from stolen Bitcoin under the US tax code. Using comparable figures of 50,000 USD in fair market value and 10,000 USD in adjusted cost basis, your deemed disposition is $0 due to the nature of the transaction being theft. Under the US Tax Code IRC 1001(b) your losses are also -10,000 USD resulting from Amount Realized ($0) less Adjusted Basis ($10,000 USD).
Now unlike your Canadian neighbours you are not allowed to claim any capital losses retroactively or into the future. This cost basis is permanently unrecoverable.
This is due the combination of Section 165(h)(5) where personal theft may only be claimed in federally declared disaster areas. Additionally under Section 1222 the IRS doesn’t recognize theft as a voluntary sale or exchange thus you are unable to claim the theft of the Bitcoin to offset ordinary income.
An Exception
For both the Americans and Canadians note that on the off chance the value of your Bitcoin was insured above the cost basis any profits resulting from an insurance payout that goes above the cost basis would be subject to taxation. Keep this is mind when it comes time to discussing with your tax accountant.
To Recap
Assets get stolen. It happens. Bitcoin is no exception, even when you took all the precautions the industry endorsed. If you or someone you know is affected by the Cold Card hack or god forbid a future incident know that there is a tax framework to help minimize the financial fall out.
This is a high level commentary / tax assessment for the Bitcoin community affected by the recent Cold Card wallet attack. I am a Chartered Professional Accountant registered in Ontario, Canada. The contents of this article are an assessment of the situation for Canadians and Americans affected. This is for informational and education purposes only. Consult with your personal tax professional on your specific situation.
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