It has been a rough few months for cryptocurrency owners with values taking huge nose dives. Some currencies have come back up amidst recent bank collapse scares, but most investors are still sitting on significant losses. The issue of how to handle cryptocurrency losses for tax purposes has become increasingly important to both taxpayers and preparers alike.
Unfortunately, coming to a conclusive answer has been challenging. The Internal Revenue Service (IRS) has provided some guidance on how to handle cryptocurrency transactions for tax purposes, but there are still many questions that remain unanswered.
In general, if you sell or exchange cryptocurrency at a loss, you may be able to deduct that loss on your tax return, similar to any other investment transaction. However, there are a few important caveats to keep in mind that may not feel warm and fuzzy to taxpayers who feel like they lost significant amounts of, essentially, cash.
Probably not that surprising, but you must have actually realized the loss in order to deduct it, just like with any other traditional investment. This means that you must have sold or exchanged the cryptocurrency for less than you originally paid for it. If you are simply holding onto the cryptocurrency and its value has gone down, you cannot deduct the loss until you actually sell or exchange it. This should seem familiar to tax preparers who would be used to these rules, but taxpayers might not love this answer.
It is important to note for tax prep purposes, the IRS treats cryptocurrency as property, rather than as currency. This means that the tax rules that apply to property transactions also apply to cryptocurrency transactions. For example, if you hold the cryptocurrency for less than a year before selling or exchanging it, the loss will be treated as a short-term capital loss. If you hold it for more than a year, the loss will be treated as a long-term capital loss.
Finally, there are some limitations on how much you can deduct in cryptocurrency losses. If you have other capital gains during the year, you can offset those gains with your cryptocurrency losses. But if your losses exceed your gains, you can only deduct up to $3,000 in losses per year.
Any excess losses can be carried forward to future tax years. This again should be a familiar limit to tax preparers who are used to preparing Schedule D in this way for traditional stock sales, but taxpayers who invested in crypto may not have been clear on the regulations prior to jumping in.
The IRS has been public about their plans to crack down on cryptocurrency transactions in recent years, and there is a high likelihood that they will continue to increase their enforcement efforts in the future knowing that the market lacks regulation right now.
Tax preparers should make sure that their clients can substantiate all transaction history, especially losses, prior to including them on a return.
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