Bummed by Crypto Losses? Here Are Some Tax Tips!
Bitcoin and other digital asset investors have been crushed recently by the longest losing streak since 2011. However, even if you suffered losses on your crypto investments this year, there's still some good news!
The IRS allows investors to claim cryptocurrency loss deductions, reducing tax bills or potentially resulting in a tax refund. You can also employ investment methods throughout the year to minimize losses and make the most of your cryptocurrency investments. So, if you act quickly, you may be able to reduce your tax payment for next April and beyond!
Let's answer some common crypto tax questions for you:
1. Is it possible to deduct cryptocurrency losses from your taxes?
Yes. The IRS considers cryptocurrencies like bitcoin to be property, and they are subject to capital gains and loss restrictions. This means that any losses you incur from trading, selling, or otherwise disposing of your cryptocurrency will be offset by your capital gains and up to $3,000 in personal income. Any net losses over $3,000 can be carried forward to future tax years.
2. How do capital gains offset crypto losses?
You can use capital losses to offset unlimited capital gains in a given year.
For example: Taylor has held Apple and Ethereum for more than a year. She sells her Apple stock for a $5,000 profit. She also sells her Ethereum but at a $6,000 loss. She offsets $5,000 of capital gains and $1,000 of income. Taylor's capital loss for the year entirely cancels out her capital gains. Taylor can deduct a share of her annual income because her capital loss exceeds her overall capital gains. Her tax calculations would get more complicated if she had both short-term and long-term capital gains and losses for the year.
3. Do short-term or long-term capital gains cancel out capital losses?
Yes, cryptocurrency is taxed at a lower rate when it is sold after a holding period of 12 months.
Short-term capital losses must first offset short-term capital gains, while long-term capital losses must first offset long-term capital gains. If you have any remaining net capital losses, you can use them to offset capital gains of the other kind.
For example: Jim has $4,000 of short-term capital gains and $4,000 of long-term capital gains. He incurs a long-term capital loss of $5,000. His long-term capital loss first offsets his long-term capital gains. Jim offsets $4,000 of long-term capital gains and $1,000 of short-term capital gains.
4. Can you claim a capital loss even if you haven't sold your crypto?
Remember, you need to realize your loss to count as a capital loss that can be written off on your taxes. You must have a taxable event to realize a loss—in other words, you must dispose of your cryptocurrency to realize the loss.
The following are some examples of disposals:
- Trading crypto for fiat currency or selling crypto for fiat currency (like USD)
- Exchanging one coin for another
- Using cryptocurrency to purchase a product or service
That means you won't be able to deduct any losses if you hold your cryptocurrency. Only when a taxable event has occurred will you be able to declare your losses.
Understanding Unrealized losses
It's considered an unrealized loss if your cryptocurrency is worth less than when you acquired it and you haven't sold it.
For example: Sabrina buys 5 ETH for $20,000. The value of her ETH falls to $15,000. Sabrina continues to hold onto her ETH. She has a $5,000 unrealized loss in this situation (20,000–15,000). She can't write this off now because she still owns the assets. Remember that Sabrina only realizes her asset loss when she sells it.
5. What if I earned crypto income and the price dropped?
Cryptocurrency earned from mining, staking, or airdrops is taxed as personal income at its fair market value at the time of receipt. This is true even if your cryptocurrency's fair market value falls. If you hold onto your cryptocurrency income, it will be regarded as an unrealized loss. If you decide to sell, you can claim a capital loss based on how much your crypto income has decreased since you first received it.
For example: Chris earns $500 in Bitcoin interest. The value of his earnings falls to $300. Chris sells his holdings. Chris reports $500 of income and $200 of capital losses.
6. Do you have to report crypto losses to the IRS?
Yes, crypto losses must be reported on IRS Form 8949.Many investors believe they are exempt from reporting to the IRS if they only have losses and no gains. This is not the case, and the IRS clearly states that you must record cryptocurrency losses on your tax return. Calculate your gain or loss from the transaction and record it on one line of Form 8949 to report your taxable events. After completing lines for each of your taxable events, add them all up and enter your total net gain or loss in the box at the bottom of Form 8949.
7. Is it possible to write off cryptocurrency that has been lost or stolen?
Investors may lose cryptocurrencies due to events such as a hack or a misplaced wallet key. These casualty and theft losses are no longer tax-deductible due to the Tax Cuts and Jobs Act of 2017.
Here are some strategies you can use throughout the year to maximize your losses and get the most out of your crypto investments:
1. Offset Capital Gains
Losses from cryptocurrency can be used to offset capital gains. When you sell, transfer, or otherwise dispose of your cryptocurrency for a profit, this is referred to as a capital gain. The amount of capital gains tax you pay is determined by the time you've held your cryptocurrency. Long-term capital losses can be used to offset long-term capital gains, whereas short-term capital losses can be used to offset short-term ones if the asset has been held for less than a year. Always remember that you can only offset losses of the same kind. If an asset has both long and short-term capital gains, it's better to harvest the short-term capital losses first to offset the higher-taxed short-term gains.
No gains? Make a Tax Deduction Claim!
If you don't have any capital gains to offset, you can deduct up to $3,000 in capital losses from your ordinary income per year under 26 U.S. Code 1211. If you have more than $3,000 in net capital losses in a given year, you can carry the excess losses to future tax years. You can use the losses for future capital gains or claim a deduction.
2. Tax-loss Harvesting
You can also use a tax-loss-harvesting strategy to offset your capital gains during the year. This method helps you prevent unrealized losses, which are losses that you don't sell and use to get a tax refund.
What Is Tax Loss Harvesting, and How Does It Work?
Tax-loss harvesting is a strategy that takes advantage of price drops in the cryptocurrency market. It involves selling crypto or other digital assets when their fair market value falls below their cost basis—the asset's value when you bought it to make financial losses. You can continue to deduct those losses from your capital gains and lower your tax burden in the same way as before. Instead of merely offsetting capital gains at the end of the year, you may do so regularly, taking advantage of price falls and making your crypto assets work harder for you.
The exception to the 'wash sale rule'
When you sell a stock at a loss and then repurchase the same stock within 30 days of the sale, it's known as a "wash sale." You can use the loss on your tax returns to offset capital gains or up to $3,000 of regular income. On the other hand, wash sales are not allowed in stock trading; therefore, you won't be able to claim a capital loss or a deduction if you used one. - The wash sale rule is as follows: The wash sale regulation does not apply to cryptocurrency at the moment.
For example: Jake purchased 1 BTC for $60,000 and sold it for $50,000 at a loss. He re-bought 1 BTC for $51,000 the next day to retain BTC in his portfolio.
Without the wash sale rule:
Sales Price - Cost Basis = Loss. For example: $60,000 - $50,000 = $10,000 The $10,000 loss can offset his other capital gains, or he can deduct up to $3,000 on his tax return.
With the wash sale rule:
Because he re-bought the same cryptocurrency right away, his loss will not be recognized. He cannot claim a capital gain on his tax return. The IRS has yet to say whether or not the wash-sale regulation applies to digital assets. (A provision in the Build Back Better Act was included that would have rendered crypto investments subject to the rule, but it was never implemented.) You can sell cryptocurrency that has lost value since you got it, lock in the loss, and then repurchase it immediately. The move has limitations; the IRS is aware that crypto investors have been doing so for years and may be searching for a way to retrieve some of their profits. To do so, the agency could look to another section of the tax code, which states that transactions must have "economic substance" to qualify for tax breaks.
Put another way: you must be willing to take some market risk before repurchasing the same coin. So, if you are wondering how long you should wait before repurchasing to keep your deduction. The most prudent method is to wait 30 days before repurchasing, just as you would with equities.
Are you thinking of selling your crypto for a loss?
Make sure you know how long you've had it — anything less than a year is considered a short-term capital loss. Short-term losses will be employed first, followed by long-term gains, to offset short-term gains (and vice versa, with long-term losses offsetting long-term gains before being applied to short-term ones). Unfortunately, if a crypto scheme defrauded you, you will no longer be eligible for a tax credit due to changes made under the 2017 tax overhaul as previously mentioned. Many scam victims were able to write off their losses before the law. They will now be responsible for those losses without the benefit of a tax write-off to cushion the shock.
Never let the threat of paying higher rates for short-term returns keep you from holding onto a crypto investment for longer than you want. If you believe your currency is at an all-time high, don't try to save a few dollars on taxes, especially given how volatile crypto markets can be.