While it's never fun to lose money on your trades, there is a silver lining to crypto losses. The IRS allows cryptocurrency investors to claim deductions on cryptocurrency losses that can lessen the tax liability, or potentially even result in a tax refund!
The IRS says I need to report my crypto taxes… but I had cryptocurrency losses?!
Sound familiar? We’ve frequently heard this sentiment from our users. With wild price swings and volatile coins, most crypto traders lived through the unfortunate reality of losing money on their trades over the course of at least one taxable year. It’s not all bad news though! Fortunately, the IRS allows cryptocurrency investors to claim deductions on cryptocurrency losses that can lessen the tax liability, or potentially even result in a tax refund!
First, it’s important to know that the IRS classifies cryptocurrency as a capital asset and every taxable event must be reported on an IRS 8949 cryptocurrency tax form, including your crypto losses. The good news is when you have crypto losses to report on your tax return, you can either use these to offset your capital gains or deduct up to $3,000 a year from your ordinary income.
Let’s dive into more on how reporting crypto capital losses works:
In 2014, the IRS issued Notice 2014-21, clarifying that virtual currency is treated as property for tax purposes and every taxable event must be reported on an IRS 8949 cryptocurrency tax form, similar to the sale of stock.
As a refresher on cryptocurrency tax reporting, the most common taxable events include:
For each bitcoin transaction or other virtual currency transaction, be sure to include the name of the cryptocurrency, the dates you acquired and disposed of the cryptocurrency, your cost basis and proceeds, and your net capital gain or loss.
You’ll then need to transfer the totals over to Schedule D, the supporting schedule of Form 1040 where you report your total capital gains and losses for the tax year. For a step-by-step walkthrough of this process, check out our blog on How to Report Cryptocurrency on Taxes.
TaxBit produces the required IRS 8949 cryptocurrency tax form, which will be transposed onto a taxpayer’s Schedule “D” tax form. Schedule D (Form 1040) is used to report the sale or exchange of capital assets that are not held for business or profit. Note that ordinary income will not be reported on Schedule D. Income from mining crypto will be added as ordinary income, similar to reporting employment income from a Form W-2.
As mentioned earlier, cryptocurrency losses can be used to offset capital gains and lessen your tax burden. In fact, savvy crypto traders often sell assets at a loss intentionally to offset capital gains with a strategy called crypto tax-loss harvesting.
When offsetting your capital gains with losses, pay attention to the holding period of the assets. You are 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.
Additionally, 26 U.S. Code § 1211 of the Internal Revenue Code provides relief in the form of a deduction for losses on capital assets. Specifically, taxpayers may deduct $3,000 in capital losses a year ($1,500 if you are married and filing a separate tax return) from their ordinary income.
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 then use the losses to offset capital gains in a future tax year, or can claim the capital loss deduction again.
Assume a taxpayer, let's call her Jane, ended the 2018 tax year with $10,000 in net capital losses and then 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. This is allowed by the IRS and is called “carrying forward capital losses.”
Now, let’s assume the same set of circumstances, with one exception: In 2019, Jane 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’s excess losses that are carried forward can 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.
“Failing to report your losses and gains could have big consequences,” said Kevin F. Sweeny, a former federal tax prosecutor. Because many exchanges have failed to issue 1099-B tax forms that report cost basis information, the IRS oftentimes does not know whether a taxpayer had net taxable gains or losses for the year. The IRS is therefore auditing any taxpayers who traded cryptocurrency, but failed to file an IRS 8949 capital gains and loss report.
The IRS has been clear in its intent to crackdown on unreported crypto gains and losses and is going after non-compliant taxpayers. The IRS has now created a dedicated virtual currency team to trace the blockchain and find non-compliant taxpayers. The IRS searches the blockchain using technologies developed by companies such as Chainalysis to identify taxpayers who traded cryptocurrency. If the taxpayers failed to file an IRS 8949, then they are an easy target for an IRS audit. You should therefore file your cryptocurrency taxes regardless of whether you had gains or losses in order to avoid an IRS audit.
Check out these articles for more information on crypto tax laws:
As discussed above, the lowest hanging fruit for an audit is if a taxpayer has not filed an IRS 8949 cryptocurrency tax form at all. For that reason, you must disclose your capital gains and losses on your crypto trades. However, if you claim a substantial amount of losses then the IRS may want to investigate to verify that everything was reported properly.
Leading CPA firms and cryptocurrency tax attorneys are amazed at the level of detail TaxBit provides through its audit trail. With TaxBit, a taxpayer, CPA, or IRS auditor can filter by any transaction such as a Bitcoin transaction, and then drill-down to see exactly how the crypto cost basis and subsequent capital gains and losses were calculated.
Trust the experts! TaxBit is here to help you with your crypto tax prep to maximize your tax savings.
Yes, since the IRS classifies Bitcoin and all cryptocurrency as capital assets, you can deduct up to $3,000 per year ($1,500 if you are married and filing a separate tax return) from your ordinary income.
Yes, cryptocurrency losses are tax deductible. If you don't have any capital gains to offset with your cryptocurrency losses, you can deduct up to $3,000 per year from your ordinary income.
The amount of tax you pay on crypto gains depends on how long you held the asset for. If you held the asset for less than one year, your cryptocurrency gains will be taxed as a short-term capital gain (equal to your ordinary income tax rate), ranging from 10% – 37%. If you held the asset for more than one year, it will be taxed at the long-term capital gains tax rate, ranging from 0% – 20%.
If you don’t report crypto on form 8949, it is likely you will face an IRS audit. You should file your cryptocurrency taxes regardless of whether or not you had gains or losses in order to avoid an IRS audit.