Celsius ,Terra TAX Impact ? Complete Guides Platform and Protocol Failures 2024

The Celsius Network bankruptcy and the failure of Terra have caused many questions for taxpayers caught in the middle. Throughout 2022, the crypto economy has been in the throes of a bear market, which has taken a heavy toll on investors, platforms and protocols. While investors have watched the value of their holdings drop, there has been an uptick in failures at the platform and protocol levels, which has added fuel to the fire of investment losses and caused many questions for taxpayers caught in the middle.

Let’s examine two of the larger events to occur this year: the Celsius Network bankruptcy and the failure of Terra and its cryptocurrency LUNA, and discuss the potential tax implications of each.

What is Celsius ?

Celsius was a crypto lending platform that advertised very high interest rates on various cryptocurrencies that its 1.7 million users transferred to the platform. At its peak, the company held almost $12 billion worth of customer deposits under management. Then, on June 12 of this year, facing a liquidity crisis, Celsius posted a memo online informing its users that all withdrawal, swap and transfer functionality would be temporarily paused. A month later, on July 13, the company filed for Chapter 11 bankruptcy protection.

For customers of Celsius, there are many questions related to the failure of the platform. One that we often hear in our tax practice is, “Can I deduct my Celsius losses?”

The deductibility of Celsius losses hinges on the concept of bad debt, which is outlined in Section 166 of the Internal Revenue Code and related regulations. Since most Celsius customers are individual investors, we will look specifically at Section 166(d), which deals with nonbusiness bad debts, defined as any debt not related to the taxpayer’s trade or business. Generally, a nonbusiness bad debt is recognized as a short-term capital loss on a taxpayer’s return.

Two requirements need to be met to recognize a loss from a nonbusiness bad debt on a tax return:

1. There must be a bona fide debt
2. The debt must be completely worthless

Under Regulation Section 1-1.66-1(c), a bona fide debt is based on “a valid and enforceable obligation to pay a fixed or determinable sum of money” at some point. The determinable sum of money involved here would be the value of crypto deposited into Celsius.

For the debt to be completely worthless, it must be considered wholly uncollectible. It is important to note that under the regulations there is no mechanism for partial deductibility of nonbusiness bad debts. Instead, the entire debt must be worthless to deduct the bad debt as a capital loss.

Many taxpayers believe that Celsius’ bankruptcy filing is grounds to consider its underlying debts worthless; however, Regulation Section 1.166-2(c) holds that bankruptcy only indicates the worthlessness of “at least part of” a debt. Remember from above that the debt must be completely worthless to recognize a capital loss, so the regulations are reasonably clear here that bankruptcy proceedings don’t guarantee complete worthlessness.

So, what is a person who has crypto locked inside Celsius to do? The short answer is to wait and see. Once bankruptcy proceedings are finalized, some or all of the funds owed by Celsius to its customers may be paid back. But until we know for certain how much, if any, will be returned to customers there is no allowable tax loss. The entire tax code revolves around realization events – the consummation of transactions that have an economic effect – which trigger recognition of income, deductions, gains and losses. In this situation, there has been no realization event yet. In short, nothing has happened from a tax perspective.

How to Work Celsius ?

Celsius refers to a temperature scale. It likely doesn’t require any specific actions to “work” with it. Here’s how you can understand and use Celsius:

• Understanding the Scale:
  • 0 °C is the freezing point of water.
  • 100 °C is the boiling point of water.
  • Numbers below 0 °C indicate temperatures below freezing, and numbers above 100 °C indicate temperatures above boiling.
• Converting Between Celsius and Fahrenheit:
  • You may encounter temperatures in Fahrenheit (°F), especially in some countries like the United States. There are formulas and online tools to convert between Celsius and Fahrenheit. Here’s a rule of thumb for a rough estimate:
    • To convert from Celsius to Fahrenheit, multiply by 9/5 (or 1.8) and add 32.
    • To convert from Fahrenheit to Celsius, subtract 32 and then multiply by 5/9 (or divide by 1.8).
• Everyday Use:
  • Celsius is commonly used in weather forecasts and scientific measurements.
  • Many ovens and thermostats allow you to choose between Celsius and Fahrenheit.

Is there anything specific you’d like to know about using Celsius?

What is Terra ?

The Terra ecosystem was a decentralized finance (DeFi) project that provided high yields to investors. During 2022 the yields offered on staked deposits of its native stablecoin terraUSD (UST) were nearly 20% per year.

TerraUSD is an algorithmic stablecoin that used its sister cryptocurrency, LUNA, to maintain its peg to the U.S. dollar. In May, over $2 billion worth of terraUSD was unstaked and began to be liquidated. As a result, terraUSD lost its peg to the dollar. More LUNA was minted in an effort to reclaim the peg, thereby flooding the market with LUNA tokens and diluting the value of each LUNA token in circulation. In a matter of a few days, LUNA had gone from a market price of over $120 to less than 1 cent.

Many investors saw the value of their LUNA and UST holdings fall precipitously during the crash. While it is unlikely that LUNA and terraUSD will recover their values (both are currently trading more than 95% below all-time highs), there is some relief available to investors who choose to sell their holdings and recognize a capital loss.

As mentioned previously, realization events form the backbone of the Internal Revenue Code (IRC). IRC Section1222 discusses various types of capital gains and losses, all stemming from the “sale or exchange” of a capital asset. In short, in order for a capital loss to be recognized an investor must first sell the asset at a loss. Continuing to hold LUNA (now trading as LUNC) or UST precludes loss recognition because no sale has occurred. The silver lining here is that both UST and LUNC are still available to trade on many exchanges, so selling the assets at a loss is possible.

Celsius and Terra are not the only major failures we have seen. Numerous other platforms and protocols have succumbed to the bear market over the course of 2022. For taxpayers caught in the middle there is some relief available through deductible losses – as either bad debts or capital losses, depending on the situation – but not until there is some triggering event that causes realization of those losses. If you are a taxpayer with exposure to a failed crypto project, consult your tax adviser to determine the best course of action in your case.

How to Work Terra ?

Terra can refer to two things: Terraform Labs’ blockchain platform or Workterra, a benefits administration platform. Based on your previous questions about cryptocurrency, I’ll assume you’re interested in learning about Terraform Labs’ blockchain platform. Here’s a breakdown of how to work with Terra:

Getting Started:

1. Create a Terra Account: You can sign up for a free Terra account using your Google account.
2. Install Terra Station Wallet: This is a crypto wallet extension that allows you to store, send, and receive Terra (Luna) tokens and other cryptocurrencies supported by the Terra blockchain. You can download it from the official website https://station.terra.money/.

Using Terra:

• Buying and Selling Luna: You can buy and sell Luna tokens on cryptocurrency exchanges that support Terra. Once you have Luna in your Terra Station wallet, you can use it for various purposes on the Terra ecosystem.
• Staking Luna: Staking your Luna allows you to earn rewards for helping to secure the Terra network. You can stake your Luna directly on the Terra Station wallet.
• Using Terra Applications (dApps): Terra supports a variety of decentralized applications (dApps) built on its blockchain. These dApps offer various functionalities like lending, borrowing, and synthetic assets. You can explore and interact with these dApps through the Terra Station wallet or their individual user interfaces.

Additional Resources:

• Terra Docs provide comprehensive guides and tutorials on using Terra, including staking, using dApps, and building on the platform.
• Terra Support offers troubleshooting guides and answers to frequently asked questions.
• Terra Community Forums: The Terra community forums are a great place to connect with other users, developers, and enthusiasts. You can find discussions, ask questions, and stay updated on the latest developments within the Terra ecosystem.

Important Note:

The world of cryptocurrency can be complex and involves inherent risks. Before investing in Luna or using any dApps on Terra, it’s crucial to do your own research (DYOR) and understand the potential risks involved.

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