Can You Write Off Crypto Losses on Your Taxes?
Capital losses can help you lower your taxable income, but only under certain circumstances.
- He was named a "40 under 40" by the Houston Business Journal in 2021.
Let's just say 2022 wasn't the best year for cryptocurrency.
Bitcoin, the best known cryptocurrency, took a beating last year, plummeting over 60%, with many altcoins delivering similar losses. Although the time window to document crypto losses for the 2022 tax year has now ended, knowing a few crypto tax tricks can help you save money if you plan to continue investing in digital coins, stocks or other securities in coming years.
One technique, known as tax loss harvesting, lets you claim capital losses you had from cryptocurrency, investments or property on your taxes, in order to offset tax owed on future years' gains. When correctly documented, capital losses can offset any capital gains income you had in the same year, as well as up to $3,000 of taxable income for that year. If your total losses exceed $3,000, you can carry the remaining balance forward to future years' tax returns. We like this since it can help lower your taxable income, and potentially your tax bill.
Tax loss harvesting has its caveats. You can only claim capital losses from your crypto once the loss is "realized," meaning once you've sold your coins. The tax rate also varies, depending on whether or not you've held a coin for more than one year. Nevertheless, with last year delivering its fair share of industry scandals, many investors who are sitting on substantial losses may just want to sell their holdings and move on. If you do so, know that you could "harvest" your losses and save some money on taxes for years to come.
Here's a bit more about how tax loss harvesting works for crypto investors, along with what credentialed experts say you should keep in mind.
Read more: Best Crypto Tax Software
How the IRS classifies and taxes your crypto
The IRS interprets cryptocurrency as property, not a security, said Ryan Losi, certified public accountant and executive vice president at PIASCIK, an accounting firm. "In 2014 and subsequent notices, the IRS has specifically expressly said not to treat [crypto] as a security, but rather as a property," Losi said.
When you sell a property or asset for more than you paid, the difference is called a capital gain, and is subject to capital gains tax. This tax rate varies, depending on how long you held the asset. If you held the asset for one year or less, it's a short-term gain, and will be taxed the same as your income tax rate.
| Income (2022 tax year) | Capital gains tax rate (short-term) |
|---|---|
Less than $10,275 | 10% |
$10,276 to $41,775 | 12% |
$41,776 to $89,075 | 22% |
$89,076 to $170,050 | 24% |
$170,051 to $215,950 | 32% |
$215,951 to $539,900 | 35% |
More than $539,900 | 37% |
Source: IRS
In contrast, if you held your assets for more than a year, the IRS calls this capital gain a long-term gain, and will tax you at one of three rates for the 2022 tax year.
- If your taxable income was $41,675 or less, your capital gains tax rate is 0%.
- If your taxable income was between $41,676 and $459,750, the rate is 15%.
- If your taxable income was more than $459,750, the rate is 20%.
The IRS lists certain exceptions in which rates are higher, but none of them currently apply to cryptocurrency.
Then there are capital losses. If you sell an asset for less than you paid for it, it's considered a capital loss. Many people who have held bitcoin since early last year are likely sitting on a substantial capital loss at the moment. When you sell your crypto at a loss, it can be used to offset other capital gains in the current tax year, and potentially in future years, too. If your capital losses are greater than your gains, up to $3,000 of them can then be deducted from your taxable income ($1,500 if you're married, filing separately). Additionally, any unapplied losses after that can carry over and be applied to a future year's tax return.
With me so far? When you realize a loss, it can give you a tax break. This is tax loss harvesting in a nutshell, and some investors do it strategically to safeguard their future gains.
Can you sell coins, claim the loss, then buy them right back?
Technically, yes. This is one advantage to the IRS classifying crypto as a property rather than a stock.
The IRS' wash sale rule states that, if investors sell a security at a loss, then buy a "substantially identical" security within 30 days of the sales, they cannot claim these losses as capital losses on their taxes. Think of this as the IRS' way of discouraging tons of transactions (and subsequent market volatility) from people trying to game the tax loss harvesting process.
Cryptocurrencies, however, are not subject to the wash sale rule as of this writing. "If their definition later gets expanded by Congress, then OK, but until then, crypto is not considered a security," Losi said. Remember, you can't claim a capital loss until it's realized; if you're currently marinating in the crypto dip, selling your coins and then repurchasing them at a later date is technically in-bounds for now, and would let you realize the loss for tax purposes.
The technique is valuable enough that some cryptocurrency software companies offer a way to automate tax loss harvesting, said Christian Rivera, CPA and founder of The Ecommerce Accountants, an accounting firm. "What some investors do is use software tools like TaxBit to track what's called your basis in your investments. These are your realized gains or losses. If you have realized gains, but also have losses that are not realized yet, [the software can] trigger those trades so that you cash out on losses and avoid getting stuck in a huge taxable position," Rivera said.
Consult a tax professional if you plan to implement a tax loss harvesting strategy on a regular basis.
How to claim crypto losses on your taxes
When you claim crypto losses, you'll need to first document whether they were short-term or long-term losses on Form 8949. The type of loss will matter if you also have capital gains in the same tax year, said Eric Bronnenkant, CPA and head of tax at Betterment, a financial advisory company. "If your gains exceed your losses, the character of your loss can have an impact on the net tax that you pay," Bronnenkant said. Additionally, the type of loss will matter if you plan to carry over the loss to future tax years.
Form 8949 then gets included on your Schedule D, which calculates overall net capital gain or loss. You'll then attach Schedule D to your Form 1040. If you use a cryptocurrency exchange, be sure to check and see if they've distributed a form to you, such as a 1099-MISC, so that you can match numbers up.
If you're using tax software to file your taxes this year, know that you may need to pay for a higher tier of service in order to report cryptocurrency activity.
Read more: Best Tax Software for 2023
Turn your crypto losses into a tax break
Cryptocurrency continues to endure regulatory scrutiny and a volatile market. Know the ropes when it comes to claiming capital losses and you'll be better prepared to save money when filing your taxes.