Editor’s note: This is an updated version of an article first published on August 17, 2022.
Before crypto exchange FTX imploded this week, crypto investors were in for a volatile, loss-making year that rocked the digital asset world. They observed that the price of their digital asset dropped sharply, then recovered slightly, then dropped again.
Bitcoin, for example, is now down nearly 65% year-to-date and more than 75% from its all-time high.
If you bought crypto when it was on the rise and sold your holdings this year, or are considering doing so, there are at least a few ways to cut your losses.
You can use a capital loss in cryptocurrency to offset any capital gain you’ve had this year – even if it’s from the sale of another security or another security. property such as stocks or houses.
For example, if you bought a bitcoin for $50,000 in February 2021, then sold it for $24,000 in mid-August this year, your long-term capital loss would be $26,000 because you held the investment for more than a year.
Then say you also booked a $10,000 capital gain by selling stocks held long in a taxable brokerage account (ie, not a tax-deferred account like a 401(k) or IRA).
You can fully offset the tax you owe on your $10,000 capital gain with a $10,000 capital loss on your 2022 tax return. Additionally, you can use your losses to pay down your debt this year up to $3,000 of your ordinary income.
Whatever losses you don’t use this year can be used in future years. So, in the example above, you would use half of your capital losses ($13,000) this year to offset them. $10,000 capital gain and $3,000 income. Then you can carry the other half of your losses forward. And if you have a year with no earnings to offset, you can still use $3,000 of your losses to offset taxes on $3,000 of your income.
But when you die, your losses will die with you for tax purposes. You cannot bequeath them for someone else to use. “Your heirs don’t inherit losses,” says Larry Pon, a California-based certified public accountant and certified financial planner.
Unlike stocks, you can choose to sell a losing crypto asset to claim a tax loss, but you can repurchase the same asset at the time of sale.
Here’s why: For tax purposes, crypto assets are classified as property, not securities. So, while you can use capital losses from both types of assets to offset their gains, there is another tax rule that only governs securities and does not apply to crypto assets. At least not yet.
This is called the wash-sale rule. The IRS will disallow any capital loss you claim on the sale of a stock or security if you redeem it or something “substantially identical” to it within 30 days before or after the sale.
There is no comparable regulation for cryptocurrency. “Although the IRS does not specifically focus on this area, most practitioners agree that the laundering rules do not generally apply to cryptocurrency. The IRS said they treat virtual currency as property, while the wash-sale rules apply to stocks and securities,” said Mark Luscombe, federal tax analyst for Wolters Kluwer Tax & Accounting.
So, if you book a loss but still believe the same cryptocurrency has long-term promise, you can buy it back at any time. You even sell on the same day.
“If you sell it [a cryptocurrency] and buy it back quickly, allowing you to tax the loss product without triggering the 30-day rule,” said Kell Canty, CEO of crypto tax software provider Ledgible.
This trading advantage over securities cannot last forever. Lawmakers have already proposed expanding the laundering rule to cover crypto and other assets in proposed legislation. But the chance of expansion this year is very low.
“This rule may change in the future, but for 2022, cryptocurrencies are not subject to the wash-selling rules,” Pon said.
One exception might be if you have indirect exposure to crypto assets through an exchange-traded fund such as the ProShares Bitcoin ETF (BITO).
“Trading on an exchange may allow the IRS to treat such cryptocurrency as a security [therefore] subject to wash-sale regulations,” Luscombe said.