Over the last 15 years, Bitcoin and other cryptocurrencies have soared to values beyond the wildest dreams of Satoshi Nakomoto.
These spectacular gains have minted a whole class of crypto millionaires, even after taking into account the downdraft of the 2022-2023 crypto winter.
Thankfully, crypto losses are a candidate for tax write-offs, like any other type of investment losses. That means you can use the losses to offset capital gains taxes you owe on more successful investment plays.
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How Crypto Losses Impact Your Taxes
Unless they are earning interest from staking or other scenarios, cryptocurrencies are not subject to IRS taxes when you hold them in your portfolio. However, once you sell cryptocurrency for more than you paid for it, you have capital gains to report.
The IRS may classify your sale—whether as a gain or a loss—as long-term if the asset is held one year or longer. Long-term capital gains receive favorable tax rates. If you held the asset for less than a year, it is considered short-term, and you will pay ordinary income tax rates. If you sell your crypto for a loss, the IRS allows you to offset losses against other income on your tax return.
These so-called “realized losses” can be used to offset other taxable investment profits. When you hear the term “realized,” it usually means that an asset was sold. But with cryptocurrency, you “realize” gains or losses any time you dispose of crypto, including when you spend it on purchases or exchange one crypto for another.
Let’s say you purchased an $80,000 Tesla automobile with Dogecoin. If you bought the DOGE for $40,000 several years ago, and it subsequently rose in value to $80,000—which you then spent on the Tesla—the IRS would tax the $40,000 “realized gain” as a long-term capital gain (that’s on top of any state or local sales taxes).
How to Calculate Crypto Losses
Calculating your crypto gains and losses should be simple. It’s just the difference in price between what you paid for your coins and what you sold them for.
Unfortunately, crypto exchanges are not required to keep track of this information for you. It is incumbent upon crypto investors to record this information themselves, although the best crypto exchanges will track your crypto purchases and sales prices.
There are crypto tax programs that let you upload how much of a given coin you purchased at a given date. These programs with then fill in the relevant pricing data. Many can even generate copies of IRS Form 8949, “Sales and Other Dispositions of Capital Assets,” which you submit with your annual tax filing to tabulate capital gains and losses.
Alternatively, check out our crypto tax calculator to see how much you owe in capital gains taxes on your crypto profits.
The Wash Sale Rule and Crypto
There’s an extra benefit that cryptocurrency has over stocks and other conventional assets when selling at a loss. In 2014, the IRS said that for tax purposes, virtual currency should be treated as property rather than as a capital asset, like a stock.
This is important because capital assets are subject to wash sale rules while property is not.
Wash sale rules bar investors from harvesting tax benefits by selling capital assets for a loss and then immediately repurchasing the same or a broadly similar asset within thirty days of the sale. Since crypto isn’t considered a capital asset, it’s not subject to the rule.
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 again.
Long-Term vs. Short-Term Capital Gains and Losses
Another important component to reporting your crypto gains and losses is how long you held your crypto.
Capital gains and losses are divided into two groups: short-term and long-term. Short-term capital gains or losses are assets held for less than a year. Long-term capital gains or losses are assets held for a year or more.
Long-term capital gains get taxed at a lower rate than short-term gains.
Gains and losses are netted against each other, which happens in a few steps. First, short-term losses offset short-term gains. Then long-term losses offset long-term gains. If there are any remaining losses, short-term losses may offset long-term gains, and vice versa.
Capital Loss Carryforward
If you still have a loss after these steps, you can deduct your losses against your regular income. This deduction is limited to $3,000 each year, or $1,500 if you are married filing separately.
Losses above $3,000 will be separated back into short-term and long-term, and they will be carried over into the next tax year. Those losses are then netted against the following year’s gains until they get used up.
How to Report Crypto Losses on Your Taxes
Reporting crypto gains and losses on your taxes is a multi-step process. Once you have your transaction data—including your cost basis and proceeds—here are the next steps:
Step 1: Breaking Out Short and Long-Term
When reporting gains and losses on your taxes, you will need to break your transactions into short-term and long-term. 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 have to choose the option that states this.
Step 2: Reporting on Form 8949
Once your transactions are broken out into these groups, they get reported on Form 8949. Each transaction should have the following information:
- Description (usually the quantity and the coin, such as “.012 BTC”)
- Acquisition date
- Disposition date
- Proceeds (sale price)
- Cost basis
In the last column, calculate the gain or loss by subtracting the cost basis from the proceeds. All transactions are then totaled at the bottom of each 8949.
Step 3: Schedule D and Form 1040
The totals from each 8949 then get collected on Schedule D. This is where short-term and long-term gains 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.
Writing Off Worthless Crypto
Did you buy a coin this year that went bust? If there is still some value to the coin, even a tiny bit, you can sell your holdings and report the loss on your taxes. But if the coin has gone completely to zero and is no longer traded on any exchange, you’re out of luck.
That’s when the cryptocurrency is declared worthless in the eyes of the IRS.
Normally a capital asset, like a stock, can be deducted in the tax year that it is declared worthless. But as we learned earlier, cryptocurrency is considered a property and not a capital asset.
This means that when a cryptocurrency is declared worthless, it’s treated differently than a normal investment loss. It’s treated as a miscellaneous itemized deduction instead. Miscellaneous itemized deductions are no longer allowed after the Tax Cuts and Jobs Act passed in 2017.
This act is due to sunset at the end of 2025, however, so it’s possible in the future this tax treatment will change.
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Other IRS Reporting Requirements for Crypto
To crack down on unreported cryptocurrency transactions, the IRS has added a question about digital assets to Form 1040. It requires people to disclose whether they received or disposed of any digital assets that year.
Any cryptocurrency received as payment for services is taxable as income. Gifted cryptocurrency to another individual may need to be reported on a gift tax return depending on the value. For 2023, gifts under $17,000 are excluded from gift tax reporting.
While it’s better to sell when your crypto is up, these tax incentives can make selling at a loss a little less painful. If you still need tax help sorting your crypto losses, reach out to a tax preparer that specializes in cryptocurrencies. IRS guidance and regulations have been frequently updated in the past few years and will likely continue to evolve.
