Losing big in crypto? Here’s how to reduce the sting
Editor’s note: This is an updated version of an article first published on August 17, 2022.
Even before crypto exchange FTX imploded this week, shaking the foundations of the digital asset world, crypto investors had experienced a volatile and loss-making year. They saw the price of their digital assets fall, then recover somewhat, then fall back.
Bitcoin, for example, is now down about 65% year-to-date and more than 75% from its all-time high.
If you bought a cryptocurrency when it was on the rise and sold your holding this year – or plan to do so – there are at least two ways to lessen the impact of your loss.
You can use a loss in crypto to offset any capital gain you’ve made this year – even if it’s from selling another security or another property, such as stock or a house.
For example, suppose you bought bitcoin at $50,000 in February 2021 and then sold it in mid-August of this year at $24,000, you would have a long-term capital loss of 26,000 $, because you have held the investment for more than a year.
Then suppose you also booked a $10,000 capital gain by selling a long-held stock in a taxable brokerage account (i.e. not a tax-deferred account like a 401(k) or a IRA).
You can fully offset the tax owed on your $10,000 capital gain with $10,000 of your capital losses on your 2022 tax return. Additionally, you can also use your losses to offset the tax owed on up to $3,000 of your regular income this year.
Whatever losses you don’t use this year, you can still use in future years. So, in the example above, you would use half of your capital losses this year ($13,000) to offset your Capital gain of $10,000 and income of $3,000. Then you can carry the other half of your losses forward to future years. And if you have a year where you have no gains to offset, you can still use $3,000 of your losses to offset taxes on $3,000 of your income.
But when you die, your losses will die with you for tax purposes. You cannot bequeath them for someone else to use. “Your heirs don’t inherit the losses,” said California-based CPA and certified financial planner Larry Pon.
Unlike stocks, you can choose to sell a losing crypto asset to claim the tax loss, but then buy the same asset again at the time of the sale.
Here’s why: for tax purposes, crypto assets are classified as property, not securities. So while you can use capital losses from both types of assets to offset your gains, there is another tax rule that only governs securities and does not apply to cryptoassets. At least not yet.
This is called the wash-sell rule. The IRS will disallow any capital loss you claim on the sale of a stock or security if you redeem it or something “substantially identical” to it within 30 days before or after the sale.
There is no comparable rule for cryptography. “Although the IRS has not specifically addressed the area, most practitioners are of the view that wash sale rules generally do not apply to crypto. The IRS has said it treats virtual currency like property, while wash sale rules apply to stocks and securities,” said Mark Luscombe, senior federal tax analyst for Wolters Kluwer Tax & Accounting.
So if you book a loss but still think the same crypto asset has long-term promise, you can buy it back at any time. Even the same day you sell.
“If you sell [a cryptocurrency] and redeeming it quickly will allow you to reap tax losses without triggering the 30-day rule,” said Kell Canty, CEO of crypto tax software provider Ledgible.
This trading advantage over securities may not last forever. Lawmakers have already proposed extending the wash sale rule to cover crypto and other assets in the proposed legislation. But the chances of that expansion happening this year are very low.
“This rule may change in the future, but for 2022 crypto assets are not subject to the wash sale rules,” Pon said.
An exception may be if you have indirect exposure to crypto assets, such as through an exchange-traded fund that trades on an exchange, such as the ProShares Bitcoin ETF (BITO).
“Exchange trading could allow the IRS to treat such crypto as security and [therefore] subject to wash sale rules,” Luscombe said.