By Anthony Diosdi
Did you lose money trading cryptocurrency this year? If so, you may have the opportunity to reduce your tax bill. This article will discuss the losses associated with cryptocurrency that can and cannot be claimed on a tax return.
Claiming Ordinary and Capital Losses Associated With Cryptocurrency
A cryptocurrency investor is allowed to utilize losses to the extent of gains from sales up to $3,000 ($1,500 in the case of a married individual filing a separate return) annually against ordinary income such as wages. Any losses exceeding $3,000 can be claimed in future tax years. A cryptocurrency trader may also claim capital loss deductions under Internal Revenue Code Sections 1211 and 1212. When a crypto investor offsets capital gains with losses in cryptocurrency, the investor is permitted to offset long-term capital losses (long-term capital gains are derived from assets that are held for more than one year before they are disposed of) against long-term capital gains. Investors are allowed to offset short-term capital losses against short-term against short-term capital gains (a short-term capital loss is a loss incurred after selling an asset less than a year after it was acquired).
Some investors in securities are permitted to deduct losses on worthless investment securities found in Internal Revenue Code Section 165(g). These rules permit a loss deduction for a stock that becomes worthless during a tax year. However, since cryptocurrencies are not securities, a crypto investor cannot utilize Section 165(g) worthless security loss rules.
Casualty or Theft Losses for Purposes of Cryptocurrency
Theft of cryptocurrencies have been increasing. Internal Revenue Code Section 165(c)(3) allows a deduction for certain casualty or theft losses not connected to a transaction entered into for profit (or incurred in a trade or business). Because many cryptocurrency are “transactions engaged into for profit, while not associated with a trade or business,” they can be classified as investment losses under Section 165(c). However, after the 2017 tax year, under Section 165(h)(5) of the Internal Revenue Code, an otherwise deductible casualty or theft loss may be deducted only to the extent attributable to a disaster declared by the President. Section 165(h)(5) of the Internal Revenue Code is set to sunset in 2026. Thus, until Section 165(h)(5) expires in 2026, theft losses are not deductible by individuals outside the context of a federally-declared disaster.
Wash Sale Rules
Internal Revenue Code Section 1091 prohibits an investor from claiming a tax deduction if he or she sells an investment at a loss and repurchases the same investment, or a substantially identical asset within 30 days (60 days for married couples) before or after the sale. The rule is designed to prevent investors from using a temporary dip in an investment’s value to obtain a tax loss and then turn around and require the asset with a more favorable cost basis.
Since cryptocurrency is not a stock or security, the Section 1091 “wash sale rules” do not apply to cryptocurrency transactions. Thus, wash sales involving cryptocurrency are still possible. However, this may change in the future
Conclusion
Overall, cryptocurrency is still an emerging asset class with a largely undefined tax framework. Any cryptocurrency investor should seek guidance from an experienced tax attorney to determine how to best maximize any losses suffered trading crypto assets.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on international and domestic tax planning. He advises multinational companies, closely held businesses, and individuals on a host of complicated tax matters. Anthony has authored numerous articles on international and domestic tax planning.
Anthony Diosdi is a frequent speaker at international tax seminars. Anthony Diosdi is admitted to the California and Florida bars.
Diosdi Ching & Liu, LLP has offices in San Francisco, California, Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.