Minimize Crypto Taxes: Loss Write-Off Strategies

In today's environment of declining digital asset values, frozen accounts, and bankruptcy filings, if you have investments in digital assets like virtual currency, cryptocurrency, or non-fungible tokens (NFTs), you might be questioning when to report losses on your tax return.

The IRS treats digital assets as property. The tax implications of a digital asset transaction depend on its intended use. If you held or are holding digital assets as investments, they are classified as capital assets, and specific tax rules apply to calculate gains and losses from these investments. (Note: This advice pertains only to digital assets held for investment. For assets held for other purposes, consult IRS Publication 544, Sales and Other Dispositions of Assets, and IRS Notice 2014-21 for additional details.)

How to use crypto losses to lower your taxes?

Yes, you can write off crypto losses on your taxes. Crypto losses can offset taxes on capital gains from various assets, including stocks, real estate, and profitable crypto trades. Reporting these losses on your tax return is essential, as it can lower your taxable income and result in significant savings on your tax bill.

Crypto losses can also offset up to $3,000 in other income annually, providing additional tax relief. If your losses exceed this limit, you can carry them forward to future tax years to offset future gains.

In this guide, we teach you how to maximize tax advantages from cryptocurrency losses during both the current and future tax seasons, helping you create a comprehensive crypto tax strategy.

Steps to Report Your Crypto Losses

Reporting crypto losses on taxes is crucial for two primary reasons:

IRS Requirements: The IRS requires you to report all sales of crypto, as it considers cryptocurrencies property.
Tax Benefits: You can use crypto losses to offset capital gains (including future capital gains if there is applicable carryover) and/or deduct up to $3,000 from your income.

There are two main ways reporting crypto losses can lower your taxes: through income tax deductions and by offsetting capital gains.

Income Tax Deduction

If you experience total capital losses across all assets, you may deduct up to $3,000 from your income. If you had total capital gains across all assets, you cannot deduct these losses from your income, but you can use them to offset capital gains from other assets.

Excess net capital losses can also be carried forward to future years to be deducted against capital gains and up to $3,000 of other kinds of income.

Offsetting Capital Gains

Regardless of your assets' overall performance, virtual currency losses can be used to offset other capital gains, either from the current tax year or future tax years (if carried forward).

Example of Offsetting Capital Gains:

In 2022, Tim had net gains of $4,000 and net losses of $30,000, resulting in an overall capital loss of $26,000, which she reports on her income taxes.
In 2023, she has an overall gain of $15,000. She can use $15,000 of her $26,000 losses from 2022 to completely offset her gains.
In 2024, Tim has $20,000 of overall gains. She uses the remaining $11,000 of her 2022 losses to offset some of her gains, reducing her capital gains total to $9,000.

Strategically selling assets at a loss to offset your gains is called crypto tax-loss harvesting.

Do Capital Losses Offset Short-Term or Long-Term Capital Gains?

Capital losses are first applied to offset capital gains of the same nature. Short-term losses are first subtracted from short-term gains, and long-term losses from corresponding long-term gains. If net losses of either type remain, they can then be used to offset gains of the opposite kind.

Example of Offsetting Short-Term and Long-Term Gains:

Short-term capital gains: $5,000
Short-term capital losses: $7,000
Long-term capital gains: $8,000
Long-term capital losses: $6,000

Step 1: Apply losses to offset gains of the same nature.

$5,000 short-term capital gains - $7,000 short-term capital losses = -$2,000 short-term net loss.
$8,000 long-term capital gains - $6,000 long-term capital losses = $2,000 long-term net gain.

Step 2: If there are remaining losses of either type, apply them to offset gains of the opposite kind.

In this example, we have $2,000 in short-term losses that can offset long-term gains of $2,000, resulting in no long-term capital gains for tax purposes.

By following these steps, you can ensure that you are accurately reporting your crypto losses and maximizing your tax benefits.

Tax Reduction through Crypto Loss Claims

There is theoretically no limit to how much you can save on your taxes by reporting crypto losses if you have corresponding capital gains from other assets. U.S. taxpayers can also use crypto capital losses to offset ordinary income, up to $3,000 per year.

To claim a loss, you need to have made a crypto taxable event on the asset, such as selling, trading for another crypto, or spending crypto. Otherwise, the loss remains unrealized and cannot be reported as a capital loss.

Crypto Tax Loss Harvesting Strategies

With crypto tax-loss harvesting, you can identify unsold assets that are at a loss before the end of the tax year. For instance, if you invested in many ICOs, you might hold some coins that you can sell to claim a loss and lower your tax liability.

After ensuring you meet the conditions for tax-loss harvesting, consider using tools like the TokenTax Tax Loss Harvesting Dashboard, which helps you quickly and easily realize losses to reduce your tax liability.

Offset Gains with Crypto Losses

You can sell crypto at a loss and purchase it again. However, selling and rebuying an asset within 30 days is considered a crypto wash sale. In the U.S., wash sales are not permitted for securities to prevent taxpayers from claiming artificial losses and maximizing their tax benefits.

Since cryptocurrency is not considered a security, wash sales are technically permitted for crypto. This might change in the future, as politicians and regulators have indicated that the rule may be extended to crypto. We recommend using safer strategies to reduce your capital gains totals.

By following these strategies, you can effectively use your crypto losses to save on taxes and optimize your financial planning.

Calculating Your Crypto Investment Losses

To calculate your crypto capital losses, you follow the same formula used for gains: Proceeds - Cost Basis = Capital Loss.

"Proceeds" refer to the total amount received from the sale or disposal of the asset, while "Cost Basis" includes the original purchase price plus any associated fees, such as transaction or gas fees. If the result is negative, it indicates a loss.

Understanding Short- and Long-Term Capital Gains and Losses

Short-term capital gains and losses arise from the sale of assets held for one year or less. These are taxed as ordinary income, which in 2022 could range from 10% to 37%.

Long-term capital gains and losses result from the sale of assets held for more than one year. These benefit from lower tax rates, specifically 0%, 15%, or 20% for 2022.

Example of Calculating a Capital Loss

Imagine you purchase 5,000 UST on Coinbase for $5,000 and incur a 1% transaction fee ($50), bringing your total cost basis to $5,050.

Following the Terra Luna crash, you sell your 5,000 UST for $100:

$100 (Proceeds) - $5,050 (Cost Basis) = -$4,950 (Loss).

This $4,950 loss would be reported on your taxes.

Netting Losses and Gains

After calculating losses and gains from individual transactions, it's important to compute your net capital gains or losses. This involves summing all gains and subtracting all losses. If the total is a net loss, you have the option to carry this forward to offset future gains in subsequent tax years, up to $3,000 per year against ordinary income.

This process not only helps in managing your tax liabilities but also in planning your investment strategy for the future. Ensuring accurate calculations and understanding the implications can aid significantly in optimizing your tax position.

No Tax Forms? You Should Still Report Crypto Losses

As a U.S. taxpayer, it's your responsibility to adhere to tax regulations, which include reporting all your crypto transactions to the IRS, regardless of whether you receive any tax forms from exchanges.

While platforms like Coinbase report certain user activities to the IRS, they may not always provide tax forms directly to users. Despite this, the IRS may contact crypto investors to ensure compliance, sometimes urging them to report their transactions or pay additional taxes.

Many prominent crypto exchanges issue Form 1099s for investors who earn over $600 in rewards income, thereby also notifying the IRS of these transactions. However, not all exchanges provide 1099s. In such cases, the IRS might use a John Doe summons—an investigative tool increasingly utilized under the Biden administration—to gather information directly from exchanges.

Forms to Use When Reporting Crypto Losses

To report crypto losses, you should use Form 8949 and Schedule D of Form 1040. Form 8949 is used to report each crypto transaction within the tax year. If you have non-crypto investments, these should be reported on separate Form 8949s.

Your aggregate short-term and long-term gains and losses are then summarized on Form 1040 Schedule D, where you can also include any losses carried forward from previous years.

Challenges of Reporting Crypto Tax Losses

Reporting each cryptocurrency trade’s losses can be complex and time-consuming. Additionally, when crypto is transferred between wallets or exchanges (e.g., from Coinbase to Binance), it can complicate the calculation of gains and losses since exchanges might not track the original cost basis of transferred coins.

These complexities underscore the importance of meticulous record-keeping and possibly seeking assistance from tax professionals who specialize in cryptocurrency to ensure accurate reporting and compliance with IRS regulations.

Extra IRS Documentation Needs for Crypto

To address undisclosed cryptocurrency transactions, the IRS has implemented a new question on Form 1040 concerning digital assets. This question mandates that individuals disclose whether they have received, sold, sent, exchanged, or otherwise disposed of any digital assets during the tax year.

Cryptocurrency received as payment for services must be reported as income and is taxed accordingly. Furthermore, if you gift cryptocurrency, it may need to be reported on a gift tax return if its value exceeds certain thresholds. For the year 2023, the IRS has set the gift tax exemption limit at $17,000 per recipient.

While it is often advantageous to sell your crypto holdings when they are profitable, there are tax incentives that can lessen the impact of selling at a loss. If you find navigating the tax implications of cryptocurrency challenging, it may be beneficial to seek the expertise of a tax professional who specializes in cryptocurrency transactions. Given the rapid changes in IRS guidelines and regulations regarding digital assets, it's crucial to stay informed about the latest tax rules.

Additionally, it's important to keep track of all your crypto transactions throughout the year, as this will aid in accurate reporting and potentially avoid conflicts with the IRS. Automated tools and software designed for crypto tax compliance can also help manage and track your transactions efficiently.

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