The Internal Revenue Service allows taxpayers to use losses in stocks and other investments, including crypto, to offset gains. If your losses exceed your total gains for the year, you can deduct up to $3,000 from your taxable income. Losses over $3,000 can be carried forward each year until death to offset gains in future years.
Here’s the catch: you actually have to sell the investment to sustain the capital loss; it cannot simply have lost value on paper. But crypto investors are getting a special deal. Stock owners must follow what is known as the wash sale rule; if they sell a stock at a loss, they must wait 30 days before buying the same stock again, otherwise it will not be eligible for a deduction.
So far, the IRS has not said that the wash sale rule applies to digital assets. (There was a provision included in the Build Back Better Act that would have made crypto investments subject to the rule, but that failed.)
This means you can sell a crypto that has lost value since you bought it, lock in the loss, then immediately turn around and buy it back. This decision has its limits – the IRS knows that crypto investors have been doing this for years and may be looking for a chance to recoup that revenue. To do so, the agency could turn to another part of the tax code that requires transactions to have “economic substance” to qualify for tax benefits, according to Matt Metras, an accountant in Rochester, New York, who represents the taxpayers before the IRS. . In other words, you need to expose yourself to some sort of market risk before buying back the same coin.
The big question then is how long you have to wait before buying back to still benefit from the deduction. The most conservative approach is to wait 30 days, as you would with stocks, before redeeming. But most of the accountants I spoke to argued that you would be able to make a pretty convincing case in a shorter time that you exposed yourself to market risk given the volatility of the crypto market.
How much shorter is someone guessing. The IRS hasn’t issued detailed crypto guidelines since 2019. Whether you wait 20 minutes or 20 days really comes down to your personal risk tolerance: are the tax savings worth the potential pain and scrutiny? an audit ?
Separately, there has been some buzz lately about fully reversing losses on coins that have been completely decimated, like Luna, meaning you can deduct the full amount of losses from your taxable income without being subject to up to an annual limit of $3,000. .
That’s a no-no for most. To meet IRS requirements for a full investment write-off, the coin must be genuinely worthless. Even if Luna tanked, it’s still worth something. And its creator has come up with a recovery plan, so it may become more valuable in the future. Additionally, you must completely dispose of the asset to claim full write-off – you will need to send it to a burn wallet (which removes the coin from circulation).
There is a $3,000 cap workaround for those who are full-time traders, provided they follow certain rules. If you qualify for “tax trader status” and you make a special election, you recognize the gains or losses at the end of the year, without selling anything. Losses can be fully deducted from taxable income. But beware, if you’ve made any gains, they’ll be taxed as short-term gains, regardless of how long you’ve held them. That means they’ll face your regular tax rates, which are higher than long-term capital gains rates, says Sharon Yip, a CPA in Reston, Va.
If you plan to sell crypto for a loss, make sure you know how long you’ve held your coins – anything less than a year is considered a short-term capital loss. Short-term losses will be used to offset short-term gains first, then long-term gains (and vice versa, with long-term losses first offsetting long-term gains before being applied to gains short term).
Need I point out that you should never let the fear of paying higher rates for short-term gains cause you to hold onto a crypto investment longer than you would like? Colby Cross, an accountant in Seattle, says he had a client who had an eye-popping gain on Filecoin in less than a year, but was worried about paying more taxes if she sold it. If you think your coin is trading at an all-time high, don’t try to save a little on taxes, especially given how quickly crypto markets can turn, Cross warns.
Finally, some bad news: if you’ve been scammed by a crypto system, there’s no longer any tax relief following the changes brought about by the 2017 tax overhaul. Before the law, many victims of fraud could undo what they had lost. Now they will be saddled with those losses, with no tax deduction to soften the blow.
More other writers at Bloomberg Opinion:
Matt Levine’s Money Stuff: Terra is back from bankruptcy
This crypto winter will be long, cold and hard: Jared Dillian
Lessons from the Best Stablecoin in the World: Andy Mukherjee
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.
More stories like this are available at bloomberg.com/opinion