Claiming Crypto Losses: What You Need To Know

Cryptocurrency losses can be used to offset investment gains. If you sold crypto at a loss, you can subtract that from other portfolio profits. If your crypto losses exceed other investment gains, you can trim up to $3,000 from regular income. Plus, there's currently no wash sale rule for crypto, which blocks the tax break if you buy a substantially identical asset within 30 days before or after the sale. However, there is no one-size-fits-all answer to whether you can write off your crypto losses, as it depends on the specifics of your situation.

How to calculate your cryptocurrency losses

Calculating your cryptocurrency losses is a straightforward process, but it requires diligent record-keeping on your part as crypto exchanges are not mandated to track this information for you. Here is a step-by-step guide on how to calculate your cryptocurrency losses:

Tracking Crypto Transactions:

Maintain a detailed record of all your crypto transactions, including purchases, sales, trades, and disposals. Each transaction should include the following information:

• Amount and currency of the digital asset
• Fiat value at the time of acquisition
• Fiat value at the time of trade or sale

Determining Cost Basis:

The cost basis is the original value of your cryptocurrency for tax purposes. It is calculated as the fair market value of the crypto at the time of receipt, plus any fees associated with acquiring it.

Calculating Gain/Loss:

To calculate your gain or loss, use the formula:

Gain/Loss = Proceeds - Cost Basis

The proceeds refer to the fair market value of your cryptocurrency at the time of disposal, minus any fees related to the disposal.

Categorizing as Short-Term or Long-Term:

The IRS categorizes capital gains and losses into two groups: short-term and long-term. Short-term capital gains or losses apply to assets held for less than a year, while long-term gains or losses are for assets held for a year or more. The holding period starts the day after you purchase or acquire the crypto and ends on the day you trade or sell it.

Reporting on Form 8949:

You will need to report your transactions on Form 8949, which includes the following information for each transaction:

• Description (quantity and type of coin)
• Proceeds (sale price)
• Gain or loss (subtract the cost basis from the proceeds)

Schedule D and Form 1040:

The totals from each Form 8949 are then transferred to Schedule D, where short-term and long-term gains and losses are netted against each other. This is also where you determine if there is a capital loss carryforward to the next tax year. The final result, whether a gain or loss, will be reflected on your Form 1040.

Utilizing Crypto Tax Software:

To simplify the process, you can use crypto tax software or a crypto tax calculator. These tools can track your transactions, calculate gains and losses, and generate tax reports. Examples of such software include TokenTax, Koinly, and CoinLedger.

How to report cryptocurrency losses on your tax return

If you've lost money on your cryptocurrency investments, you may be able to use those losses to reduce your tax bill. Here's how to report cryptocurrency losses on your tax return:

Breaking Out Short and Long-Term Losses

Firstly, you need to separate your cryptocurrency transactions into short-term and long-term holdings. From there, you will group transactions based on whether they were reported on a 1099-B. Currently, crypto exchanges do not issue 1099-Bs, so you will need to choose the option that states this.

Reporting on Form 8949

Once your transactions are separated, you can report them on Form 8949. Each transaction should include the following information:

• Description (usually the quantity and type of cryptocurrency, e.g. "0.012 BTC")
• Date of the transaction
• Proceeds (sale price)
• Cost basis (the amount you paid for the cryptocurrency, including any fees)
• Gain or loss (subtract the cost basis from the proceeds)

Schedule D and Form 1040

The totals from each Form 8949 are then transferred to Schedule D. This is where short-term and long-term gains and losses are netted against each other. This is also where any prior capital losses are included, and where you determine if you have a capital loss carryforward for the next tax year. The final result, whether a gain or loss, will then flow to your Form 1040.

Capital Loss Carryforward

If you still have losses after offsetting them against your gains, you can deduct up to $3,000 (or $1,500 if married filing separately) of those losses from your regular income. Any remaining losses can be carried forward to future tax years and used to offset gains in those years.

Reporting Requirements

It's important to note that even if you don't receive tax forms for your cryptocurrency transactions, you are still required to report them to the IRS. The IRS considers cryptocurrencies to be property, and you must report all sales and disposals of crypto on your tax return. Failure to do so can lead to penalties and increased scrutiny from the tax authorities.

What to do if your crypto exchange goes bankrupt

If your crypto exchange goes bankrupt, there are a few things you can expect and some steps you can take to protect your assets.

Firstly, understand that there is a risk of losing access to your funds. When a crypto exchange declares bankruptcy, accounts are often frozen to prevent losses, theft, or mass withdrawals. This is done to keep funds in place so that creditors can be paid accordingly during the bankruptcy process, and to ensure that customer funds are not lost.

Secondly, you will need to file a claim and wait for the bankruptcy process to complete. The exchange should have your contact information and details of what you are owed on file. If the company declares bankruptcy, they should provide you with information about the next steps. During this process, the court will appoint someone to act as CEO, take stock of the exchange's assets and debts, and work with legal professionals to create a payback or restructuring plan. Once approved by creditors and the judge, the distribution process will begin. However, this process can take a significant amount of time, and you may only receive a portion of your funds back.

It is important to note that cryptocurrency holdings are not protected by government-backed insurance. Therefore, it is advisable to exercise caution when choosing a crypto exchange and consider utilizing decentralized custody or decentralized wallets to retain better control over your crypto assets.

To protect your crypto assets in the event of an exchange's bankruptcy, you can consider the following strategies:

• Set up a custodial wallet and simultaneously open other non-custodial crypto wallets, allowing you to transfer assets between them.
• Utilize decentralized custody, where you can store your crypto through "hot wallets" (online software) or "cold wallets" (hardware and offline devices).
• Use decentralized or DeFi wallets, which are self-custodial and give you control over your crypto.

By employing these strategies, you can reduce the risk of losing your crypto assets in the event of an exchange's bankruptcy and gain more control over your investments.

How to claim abandonment loss

To claim an abandonment loss on your cryptocurrency, you must meet certain requirements as outlined by the Internal Revenue Service (IRS). Here is a step-by-step guide on how to claim abandonment loss:

Understand the Criteria for Abandonment Loss:

According to the IRS, abandonment is proven by evaluating the surrounding facts and circumstances, which must demonstrate an intention to abandon the property and an affirmative act of abandonment. This three-prong test set by tax courts includes:

• Intention to Abandon: You must show that you intended to give up ownership and control of the cryptocurrency due to loss of value, scams, project failure, or other reasons.
• Affirmative Act of Abandonment: You must take actions that demonstrate your intention to abandon the cryptocurrency. This could include sending the cryptocurrency to a null or burner address, making it impossible for future trades.
• Permanently Discarded: The cryptocurrency must be permanently discarded from use or the transaction must be discontinued.

Evaluate Your Situation:

Ask yourself the following questions to determine if your situation qualifies for an abandonment loss:

• Did you invest in the cryptocurrency with the intention of making a profit?
• Did the cryptocurrency suddenly stop being valuable?
• Is it a non-depreciable property? (Yes, all cryptocurrencies are non-depreciable property.)
• Did you permanently discard the worthless coins by sending them to a null address or taking similar actions?

Document and Record-Keeping:

It is crucial to maintain detailed records and documentation before claiming losses on your tax return. This includes documenting the value of the cryptocurrency at the time you acquired it, your intention to discard the cryptocurrency, and any actions taken to abandon it. Keep proof of ownership before abandonment, as well as any other relevant information that demonstrates your eligibility for an abandonment loss claim.

Reporting and Filing:

When filing your taxes, report abandonment losses on Form 4797, Line 10. These losses are considered ordinary losses and are not subject to capital loss limitation rules. You can report the loss in the year you incurred it, which is typically the year you ceased ownership of the cryptocurrency.

Seek Professional Advice:

The world of cryptocurrency and its taxation is constantly evolving, so it is important to stay informed about the latest tax regulations. Consult a tax advisor or a tax attorney to ensure you are taking the correct approach and to minimize any potential civil or criminal exposure. They can guide you through the complex, fact-intensive analysis required for claiming abandonment losses.

How to avoid paying taxes on your crypto profits

While there is no way to evade crypto taxes, there are some strategies you can use to legally reduce your tax bill. Here are some tips to avoid paying taxes on your crypto profits:

• Harvest your losses: Sell your cryptocurrency at a loss to gain tax benefits. By doing so, you can offset any capital gains from cryptocurrency, stocks, and other assets, as well as up to $3,000 of income. This strategy is known as tax-loss harvesting and is a well-known practice in the stocks and equities world.
• Invest for the long term: Wait 12 months or longer before disposing of your crypto. The American tax code encourages long-term investment, so the capital gains tax on your profits will be significantly lower.
• Take profits in a low-income year: The lower your income during the tax year, the lower the tax rates you’ll pay on your cryptocurrency disposals. Therefore, consider taking profits on your cryptocurrency in years when your annual income is low, such as when you're studying full-time or between jobs.
• Give cryptocurrency gifts: Giving away cryptocurrency as a gift is typically not subject to income tax. While gifts with a fair market value above a certain amount (e.g., $17,000 or $18,000 in 2024) require a gift tax return, this form is primarily for informational purposes.
• Buy and sell cryptocurrency in an IRA: You can invest in cryptocurrency ETFs through your retirement account or use a self-directed IRA to invest directly in crypto. Self-directed IRAs allow investors to hold alternative investments such as real estate and precious metals, in addition to cryptocurrencies.
• Hire a crypto-specialized CPA: Navigating the tax code can be challenging, and a quality accountant well-versed in cryptocurrency can identify strategies to reduce your tax bill.
• Make a cryptocurrency donation: Donating cryptocurrency is one of the few instances where disposing of cryptocurrency is not taxed. Additionally, cryptocurrency donations can be treated as tax deductions, potentially reducing your tax bill further.
• Take out a cryptocurrency loan: Instead of selling your cryptocurrency, consider taking out a loan using your crypto as collateral. Taking out a loan is considered a non-taxable event, allowing you to access fiat currency without incurring a hefty tax bill.
• Move to a low-tax state or country: Relocating to a region with more favorable tax rates can significantly impact your tax burden. For example, some states in the US have no income tax, while countries like the United Arab Emirates and Malta don't tax capital gains for individual investors.
• Keep careful records of your crypto transactions: Proper record-keeping is essential to avoid potential fines and penalties. Ensure you maintain records of the price of your crypto at receipt and disposal, as well as the dates of acquisition and disposal.
• Use crypto tax software: Crypto tax software can help automate the process of tracking your transactions and identifying tax-loss harvesting opportunities, ensuring an accurate tax return.

Frequently asked questions