The IRS allows crypto investors to claim deductions on losses that can lessen tax liabilities and potentially result in a tax refund.
Investing in crypto can be an unpredictable endeavor. Wild price swings and volatile coins have caused many crypto traders to lose money on their trades over the course of at least one taxable year.
Fortunately, the IRS allows crypto investors to claim deductions on their losses. These deductions can lessen an investor’s tax liability or even result in a tax refund.
Yes, you need to report crypto losses to the IRS.
The IRS classifies cryptocurrency as a capital asset. Every taxable event—including your crypto losses—must be reported on Form 8949. As a refresher on cryptocurrency tax reporting, the most common taxable events include:
Selling your crypto for cash
Trading one cryptocurrency for another digital currency
Using cryptocurrency at a merchant as payment; applies to crypto debit cards as well
When itemizing cryptocurrency transactions on your tax forms, be sure to include the following:
Name of the cryptocurrency
Dates you acquired and sold or traded the cryptocurrency
Your cost basis and proceeds
Your net capital gain or loss
You’ll need to transfer the totals over to Form 1040 Schedule D where you report your total capital gains and losses for the tax year.
When you have crypto losses to report on your tax return, you have two options:
Report your crypto losses to offset your capital gains
Claim a capital loss deduction of up to $3,000 a year from your ordinary income
You can use these options towards your financial advantage.
A tax-saving strategy called tax-loss harvesting relies on reporting your crypto losses to offset gains. Savvy crypto traders often sell assets at an intentional loss to take advantage of this strategy.
When offsetting your capital gains with losses, pay attention to the holding period of the assets.
You’re only allowed to offset long-term capital losses against long-term capital gains and short-term capital losses against short-term capital gains.
Once you’ve offset losses of the same type, you can then use either long-term or short-term capital losses against short-term capital gains.
If you hold a particular cryptocurrency for one year or less your transaction will constitute short-term capital gains. Short-term capital gains are added to your income and taxed at your ordinary income tax rate.
If you held a particular cryptocurrency for more than one year, you’re eligible for tax-preferred, long-term capital gains, and the asset is taxed at 0%, 15%, or 20% depending on your taxable income and filing status.
The specific income levels change annually, but we’ve provided a general breakout below:
If you’re in the 10% or 12% tax brackets based on your filing status, you’ll generally pay a 0% capital gain rate.
If you’re in the 22%, 24%, or 32% tax brackets based on your filing status, you’ll generally pay a 15% capital gain rate.
If you’re in the 35% and 37% income tax brackets, you’ll generally pay a 20% capital gain rate.
Title 26—Internal Revenue Code Section 1211 provides relief in the form of a deduction for losses on capital assets. Specifically, instead of tax-loss harvesting, taxpayers could choose to deduct $3,000 in capital losses a year from their ordinary income—$1,500 if you’re married and filing a separate tax return.
Claiming your cryptocurrency capital losses can result in a higher refund on your tax return through this deduction. If a cryptocurrency investor has more than $3,000 in net capital losses in a taxable year, then the excess losses can be carried forward into future tax years. A taxpayer may use the losses to offset capital gains in a future tax year, or can claim the capital loss deduction again.
Jane ended the 2018 tax year with $10,000 in net capital losses and never traded cryptocurrency again.
Jane can claim the $3,000 deduction from her ordinary income in 2018, claim the $3,000 deduction again in 2019, claim the $3,000 deduction again in 2020, and also claim a deduction of $1,000 in 2021 for the remainder of the capital loss.
The IRS refers to this as carrying forward capital losses.
Now, let’s assume the same set of circumstances, with one exception.
Jane still ended the 2018 tax year with $10,000 in net capital losses, but, in 2019, she had net capital gains of $7,000 on her cryptocurrency transactions.
Jane can claim the cryptocurrency capital loss deduction in 2018 for $3,000 and then can carry her excess losses of $7,000 forward into 2019.
Jane can carry forward her excess losses to offset her 2019 gains dollar for dollar.
In this circumstance, Jane would effectively owe $0 in capital gains taxes because she carried forward her excess 2018 losses.
If you don’t report your taxable crypto transactions on Form 8949, you could face a potential audit by the IRS.
The IRS doesn’t say how it decides which tax returns to examine, but the assumption is that it will review information provided on a tax return; such as the answer to the virtual currency question on Form 1040 or the information on a Form 8949.
The IRS appears to pay close attention to individuals that received a Form 1099 from an exchange and will use its computer system to check the Form 1099 information against what a taxpayer reports on their tax return.
Notably, if a taxpayer answers No to the virtual currency question, or doesn’t include a Form 8949, and is issued a Form 1099 from an exchange, that taxpayer is more likely to be audited; the IRS now has information that may result in penalties on top of whatever additional tax may be owed. Honest answers are always recommended.
The IRS is actively sending taxpayers CP2000 notices where information shown on a Form 1099 didn’t match what was reported on a tax return.
Many cryptocurrency tax softwares will provide a taxpayer with tax forms, but offer no additional information about how gains and losses were calculated. Because of the lack of an audit trail, it can be difficult to adequately address the IRS’s questions without a trusted provider. Learn more about responding to CP2000 notices in our article.
Keeping up with all the paperwork and reporting regulations for digital asset transactions can be laborious and time-consuming. The more complex your crypto portfolio becomes, the more complicated your tax liabilities can get.
TaxBit helps track your crypto transactions and fills out your tax forms automatically.
We also recognize the need to support your DeFi activity, and each day we're actively working on expanding DeFi support to popular blockchains.
The initial version of our DeFi support allows you to sync in any transfers, trades, and approvals you’ve made on a DeFi platform involving ERC-20 tokens on the Ethereum network, or BEP-20 tokens on the Binance Smart Chain network.
Ready to try out the updates for yourself? Create an account or login to start.
Check out these articles for more information on crypto tax laws:
Generate your cryptocurrency tax forms now