As cryptocurrency continues to grow as an investment tool, it is essential to understand what it entails come tax time. The only question potential investors always have is if you can deduct crypto losses on your taxes. Well, the answer is yes but with certain conditions. Here is everything you need to know.
What are cryptocurrency losses?
Losses on cryptocurrency are losses incurred when you trade, dispose of, or sell a digital asset at a price that is less than you initially bought it at. They are capital losses and can be classified into two:
- Short-term losses: Properties disposed of in a time duration shorter than one year.
- Long-term losses: Properties disposed of after an amount of time larger than one year.
These losses will be applied in offsetting gains from other investment capital or curbing taxable income in some scenarios.
How crypto losses affect your tax
The Internal Revenue Service, or IRS, treats cryptocurrencies as property. Consequentially, gains and losses resulting from selling or disposing of them are included under the system of capital gains taxation. Telling the government about crypto losses has the following tax advantages:
- Offsetting capital gains: Crypto losses will be used to offset gains that have been achieved from other investment instruments like stocks, bonds, or real estates. The IRS permits you to use any amount of your crypto losses over net capital gains to be deducted to a maximum of $3,000 per year.
- Carryover of unused losses: In case your net losses exceed $3,000 in any tax year, the remaining losses can be carried forward to be deducted against future income or gains.
When are crypto losses reportable?
To report a loss on your tax return, the loss should be realized. This involves selling, trading, or otherwise having disposed of the asset. Owning an asset that depreciates and holding on to it is not a deductible loss.
In the case of worthless or discarded cryptocurrency, there are some requirements that must be fulfilled before you can report the loss:
- The asset should no longer possess any market value.
- It should have a determinable event that establishes its worthlessness or abandonment.
- The taxpayer must take affirmative actions to abandon the asset.
Instructions to report crypto losses
Accurate reporting of crypto losses involves proper documentation and adherence to IRS filing requirements. Here is how you can do it:
- Record all transactions: Maintain detailed records of all crypto transactions, including dates, amounts, cost basis (purchase price), and proceeds (sale price). Programs like crypto tax software can help make this simpler.
Fill out IRS forms
- Employ Form 8949 to report each transaction separately.
- Summary of totals on Form 1040, Schedule D (Capital Gains and Losses)
- File Your Tax Return
- Include all the necessary forms with your federal tax return.
Tax strategies for crypto losses
Investors may employ such tactics as tax-loss harvesting in a bid to optimize their tax results:
- Tax-loss harvesting: This is in the form of disposing of losing assets at a tax loss to offset gains from other investments. Suppose you have $10,000 of capital gain but you experience $10,000 of crypto losses by taking advantage of tax-loss harvesting; your net taxable gain reduces to zero.
- Reinvestment considerations: After selling assets at a loss on a tax basis, there are investors who would like to reinvest in similar assets. This is contrary to stocks and securities, which are under the “wash sale rule” by the IRS and cannot be reinvested within a short period without penalty.
Special cases: Theft or platform collapse
Investors in cryptocurrency who suffered losses from theft (i.e., hacking) or platform collapse (e.g., FTX) are also eligible for deduction under specific circumstances:
- Losses due to theft can be claimed if they were in business or trade.
- Losses of defunct platforms could be losses of capital in the event of money lost irrevocably.
Errors to avoid in reporting crypto losses
- Make sure all transactions are accurately documented.
- Avoid trying to report unrealized losses (still owned but lowered in value).
- Errors on IRS forms must be avoided; errors lead to audits.
Yes, cryptocurrency losses are taxable. By using IRS rules and tax planning techniques such as tax-loss harvesting, you can offset taxable income and roll over unused losses to your benefit in the future. Keeping proper records and adhering to reporting requirements are the keys to reaping these benefits. If in doubt, seek advice from a tax professional who specializes in cryptocurrency taxation.
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