Bitcoin Losses: Capital Loss Tax Implications

Bitcoin and other cryptocurrencies are taxed when they are sold for a profit, used to pay for a service, or earned as income. In the US, the IRS considers cryptocurrencies to be property, and any losses on investments in cryptocurrencies can be used to offset capital gains from a variety of assets such as stocks and real estate. These losses can also be used to deduct up to $3,000 from one's income. However, it is important to note that the tax treatment of cryptocurrencies can vary by jurisdiction, and it is always advisable to consult a tax professional for personalized advice.

How to calculate crypto losses

Calculating your crypto losses can be done in a few simple steps.

Firstly, you need to figure out your cost basis. This is how much it cost you to acquire the crypto asset in the first place, including any transaction fees. If the cryptocurrency was a gift, you use the fair market value of the cryptocurrency in US dollars on the day you received it as your cost basis.

Secondly, once you know your cost basis, subtract it from the value of the asset on the day you disposed of it to calculate whether you have a capital gain or loss. If you have a capital loss, you can use this to offset capital gains and up to $3,000 of income for the year.

For example, if you buy 5,000 UST for $5,000 on Coinbase and pay a 1% transaction fee ($50), your cost basis is $5,050. If you then sell your UST for $100 after the Terra Luna crash, you have a capital loss of $4,950 ($100 - $5,050).

It is important to note that you need to have disposed of the asset to claim a capital loss. This means that if you simply hold cryptocurrency at a loss, you have not realised a capital loss and cannot claim this on your taxes. Disposing of an asset includes selling for fiat currency, exchanging for another cryptocurrency, or using the crypto to purchase goods or services.

Reporting crypto losses on your tax return

Understand Crypto Losses

Cryptocurrencies like Bitcoin are treated as property by the IRS and are subject to capital gains and losses rules. This means that when you sell, trade, or dispose of your crypto at a loss, your losses can offset your capital gains and up to $3,000 of personal income. Any net losses exceeding $3,000 can be carried forward into future tax years.

Calculate Your Crypto Loss

To calculate your capital loss, use the following formula: Capital Gain/Loss = Proceeds - Cost Basis. Your cost basis is the amount you originally paid to acquire the cryptocurrency, while your proceeds are the amount you received when disposing of it.

Report Your Crypto Loss on Form 8949

Report your crypto disposals on Form 8949, which can be generated by crypto tax software. Include the date you acquired and disposed of your crypto, the price in USD at the time of receipt and disposal, and your net gain/loss. Sum up all the lines for each taxable event and enter the total net gain or loss at the bottom of Form 8949.

Carry Over to Schedule D and Form 1040

Transfer the net gain/loss from Form 8949 to Schedule D of Form 1040. This is where you'll net short-term and long-term gains/losses and determine if you have a capital loss carryforward for the next tax year.

Writing Off Worthless Crypto

If you bought a coin that has lost all its value and is no longer traded on any exchange, you cannot sell your holdings to report the loss. Cryptocurrency is considered property by the IRS, so it's treated as a miscellaneous itemized deduction, which is no longer allowed after the 2017 Tax Cuts and Jobs Act.

Other IRS Reporting Requirements for Crypto

The IRS has added a question about digital assets to Form 1040, requiring individuals to disclose whether they received, sold, exchanged, or disposed of any digital assets during the year. Any crypto received as payment for services is taxable as income, and gifted crypto may need to be reported on a gift tax return depending on its value.

Tax-loss harvesting strategies

Tax-loss harvesting is a strategy used by investors to lower the amount of tax paid to the US government. It involves selling crypto at a loss to offset the gains made on other trades, thus reducing your total tax liability. Here are some strategies to consider:

• Timing is crucial: Most people elect to harvest their losses in the last month of the tax year. If you're a US taxpayer, that means by the end of December. However, due to the volatile nature of cryptocurrency, there are multiple market dips throughout the year when tax-loss harvesting crypto could be advantageous. Taking advantage of these price dips can help investors save money and reduce stress at the end of the tax year.
• No wash-sale rule: The IRS's wash-sale rule disallows taxpayers from deducting losses on securities sold in a wash sale scenario. However, this rule does not apply to cryptocurrencies as they are not classified as securities. This means that if you've got losses built up but want to hold your crypto for the long term, you could sell your coin on a down day, realize the loss on your taxes, and immediately buy it back.
• Long-term vs. short-term capital gains and losses: It's important to keep track of how long you held your cryptocurrency. If you disposed of your crypto after more than a year of holding, it will be considered a 'long-term capital loss'. If you disposed of your crypto after less than a year, it will be considered a 'short-term capital loss'. Short-term capital losses first offset short-term capital gains, and long-term capital losses first offset long-term gains. If there are any remaining losses, short-term losses may offset long-term gains, and vice versa.
• Carry forward losses: If you still have a loss after offsetting your gains, you can deduct your losses against your regular income. This deduction is limited to $3,000 each year ($1,500 if married and filing separately). Losses above this amount will be separated back into short-term and long-term losses and carried over into future tax years.
• Consult a tax professional: Tax-loss harvesting can be a complex strategy, and it's important to understand the risks and potential tax implications. Consult a CPA or a crypto tax advisor to develop a strategy that best suits your circumstances.

Crypto wash sales

Legislators are working to close this loophole, and the Biden administration has expressed interest in crypto cases, with investigations becoming more rigorous. The Lummis-Gillibrand Responsible Financial Innovation Act, reintroduced in 2023, could potentially close the crypto wash sale loophole in the near future.

Therefore, it is recommended that taxpayers avoid crypto wash sales. When in doubt, consult a crypto tax professional for guidance.

Crypto tax software

There are several crypto tax software products available, and they all work in a similar way. You import your transaction data from wallets and exchanges, and the software calculates your gains and losses. It can also generate the relevant tax forms for your country, which you can then file yourself or send to your accountant. Some software, like TurboTax Premium, even lets you file your full tax return through the platform.

Features of Crypto Tax Software

• Importing data: You can import your transaction data from various wallets and exchanges, including Bitcoin, Ethereum, and NFTs.
• Calculating gains and losses: The software will calculate your gains and losses for all your transactions, including trading, staking, and buying NFTs.
• Generating tax reports: You can download your tax report with the click of a button. These reports can be used to complete the relevant tax forms for your country.
• Tracking your portfolio: Some crypto tax software allows you to track the price, cost basis, market value, and unrealized return for assets held across all of your wallets.
• Reducing your tax bill: You can use crypto losses to reduce your tax bill. Crypto losses can be used to offset capital gains and income.
• Customer support: Most crypto tax software providers offer customer support via email, and some also offer live chat.

Examples of Crypto Tax Software

• CoinLedger: This software is trusted by over 500,000 crypto investors. It integrates with various platforms, making it easy to import your historical transaction data.
• Koinly: Koinly is available in 20+ countries and supports 800+ exchanges and wallets. It has a simple user interface and offers both live chat and email customer support.
• TurboTax Premium: This software is offered by one of the most popular tax prep companies. It has an easy-to-use navigation system and top-notch customer support. It's the only crypto tax product that lets you file your full tax return via the platform.
• CoinTracker: CoinTracker offers a free version for those with 10,000 or fewer transactions. It provides quality customer support and can connect you with a crypto expert to help with your tax return.
• TaxBit: This software offers a user-friendly interface and robust security features, including two-factor authentication.
• ZenLedger: ZenLedger offers a free version with limited features. It has an intuitive platform and provides excellent customer support.

Choosing the Right Crypto Tax Software

When choosing crypto tax software, consider your specific needs and requirements. For example, if you have a large number of transactions, you'll want software that can handle that volume. If you need help with your full tax return, choose a platform that offers this service. Also, consider the security features and customer support options.

While crypto tax software can be a helpful tool, it's always a good idea to consult a tax professional or accountant for personalized advice. They can guide you in properly reporting your crypto gains and losses and ensure you're taking advantage of all available tax benefits.

Frequently asked questions