Crushed by Bitcoin, Other Crypto Losses? Here Are Some Tax Tips, including on being scammed
Learn the IRS rules and act promptly, and you could get a tax benefit for years to come to ease your pain.
Investors in Bitcoin and other digital assets have been pummeled recently by the longest losing streak since 2011. If that's you, you might be glad to hear that there are ways to ease some of the sting of those losses: Act promptly and you can cut your tax bill for next April and beyond.
The Internal Revenue Service allows taxpayers to use losses in stocks and other investments, including crypto, to offset gains. If your losses exceed your total gains for the year, you can deduct up to $3,000 against your taxable income. Losses beyond $3,000 can be carried forward every year until death to offset gains in future years.
Here's the rub: You have to actually sell the investment to take the capital loss; it can't just have dropped in value on paper. But crypto investors get a special deal. Stock owners have to follow what's called the wash-sale rule; if they sell a stock for a loss, they have to wait 30 days before buying the same security again, or else it won't be eligible for a deduction.
So far, the IRS hasn't said that the wash-sale rule applies to digital assets. (There was a provision included in the Build Back Better Act that would have made crypto investments subject to the rule, but it fizzled.)
That means you can sell crypto that has fallen in value since you bought it, lock in the loss, and then turn around immediately and buy it back again. The move has its limits — the IRS knows crypto investors have been doing this for years and may be looking for a chance to recoup that revenue. To do so, the agency could turn to another part of the tax code that requires transactions to have 'economic substance' to be eligible for tax benefits, according to Matt Metras, an accountant in Rochester, New York, who represents taxpayers before the IRS. In other words, you have to expose yourself to some kind of market risk before rebuying the same coin.
The big question then is how long you should wait before repurchasing to still qualify for the deduction. The most conservative approach is to wait 30 days, just like you would with stocks before rebuying. But most accountants I spoke to argued you would be able to make a pretty compelling case in a shorter period of time that you exposed yourself to market risk given how volatile the crypto market is.
How much shorter is anybody's guess. The IRS hasn't come out with any detailed crypto guidance since 2019. Whether you wait 20 minutes or 20 days really comes down to personal risk tolerance: Are the tax savings worth the potential pain and scrutiny of an audit?
Separately, there has been some buzz lately about taking a full write-off for losses on coins that have been completely decimated, like Luna, which means you could deduct the total amount of losses against your taxable income without being subject to the $3,000 annual cap.
That's a no-no for most. To meet the IRS requirements to take a full investment write-off, the coin must be genuinely worthless. Even if Luna has tanked, it's still worth something. And its creator has proposed a revival plan, so it's possible it could become more valuable in the future. Plus, you have to completely dispose of the asset to claim the full write-off — you would have to send it to a burn wallet (which removes the coin from circulation).
There is a workaround to the $3,000 cap for those who are full-time traders, provided they abide by certain rules. If you qualify for “tax trader status” and make a special election, you recognize gains or losses at the end of the year, without actually selling anything. Losses can be deducted in full from taxable income. But beware, if you've had gains, they'll be taxed as short-term gains regardless of how long you've held them. That means they will face your ordinary income tax rates, which are higher than long-term capital gains rates, says Sharon Yip, a certified public accountant in Reston, Virginia.
If you plan on selling any crypto for a loss, make sure you're aware of how long you've been holding your coins — anything under the one-year mark is considered a short-term capital loss. Short-term losses will be used to offset short-term gains first, and then long-term gains (and vice versa, with long-term losses offsetting long-term gains first before being applied to short-term ones).
Need I point out that you should never let fear of paying higher rates for short-term gains make you hold onto a crypto investment for longer than you'd like? Colby Cross, an accountant in Seattle, says he had one client who had an eye-popping gain on Filecoin in less than a year, but was worried about paying more in taxes if she sold it. If you think your coin is trading at an all-time high, don't try to save a bit on taxes, especially given how quickly crypto markets can turn, Cross warns.
Finally, some bad news: If you've been scammed by a crypto scheme, there's no more tax break following changes under the 2017 tax overhaul. Prior to the law, many fraud victims were able to write off what they lost. Now, they will be saddled with those losses, without a tax write-off to soften the blow.