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Over the past 15 years, the value of Bitcoin and other cryptocurrencies has soared to levels far beyond Satoshi Nakamoto’s imagination.
Even taking into account the crypto winter downdraft of 2022-2023, these impressive gains have created a batch of crypto millionaires.
Thankfully, cryptocurrency losses, like other types of investment losses, are tax deductible, meaning you can use them to offset capital gains taxes you would otherwise pay on more successful investments.
How cryptocurrency losses affect your taxes
Cryptocurrencies are not taxable to the IRS if you hold them in your portfolio, unless you are earning interest from staking or other scenarios. However, if you sell cryptocurrencies for more than you bought them for, you will have to report a capital gain.
The IRS may classify a sale (whether at a gain or loss) as long-term if the asset is held for more than a year. Long-term capital gains are taxed at favorable rates. If you hold the asset for less than a year, it is considered short-term and is taxed at ordinary income rates. If you sell cryptocurrency at a loss, the IRS will allow you to offset the loss against other income on your tax return.
These so-called “realized losses” can be used to offset other taxable investment gains. When you hear the word “realized,” it usually means that an asset has been sold. But with cryptocurrency, a gain or loss is “realized” any time you dispose of cryptocurrency, including when you use it to make a purchase or exchange one cryptocurrency for another.
For example, let's say you buy an $80,000 Tesla car with Dogecoin. If you bought DOGE for $40,000 a few years ago and its value has since increased to $80,000 and you use that to buy the Tesla, the IRS will tax you on your “realized gain” of $40,000 as a long-term capital gain (this is in addition to any state and local taxes).
How to calculate cryptocurrency losses
Calculating cryptocurrency profits and losses is easy: just calculate the difference between the price you bought a coin for and the price you sold it for.
Unfortunately, cryptocurrency exchanges are not required to track this information on your behalf. While the best cryptocurrency exchanges will track the buy and sell prices of cryptocurrency, it is incumbent on cryptocurrency investors to record this information themselves.
There are cryptocurrency tax programs that allow you to upload how much of a particular coin you bought on a particular date. These programs will populate you with the relevant price data. Many programs will also generate a copy of IRS Form 8949, “Sales and Other Dispositions of Capital Assets,” to submit with your annual tax return to tally up your capital gains and losses.
Alternatively, use our cryptocurrency tax calculator to find out how much capital gains tax you'll owe on your cryptocurrency profits.
Wash Sale Rules and Cryptocurrencies
If you sell at a loss, cryptocurrencies have an added advantage over stocks and other traditional assets: In 2014, the IRS said that for tax purposes, cryptocurrencies should be treated as property, rather than a capital asset like stocks.
This is important because real estate is not subject to the wash sale rules, whereas capital assets are.
Wash sale rules prohibit investors from receiving tax benefits by selling a capital asset at a loss and then immediately buying back the same asset or a substantially similar asset within 30 days of the sale. Cryptocurrencies are not considered capital assets and therefore are not subject to these rules.
This means that if you are accumulating losses but want to hold your cryptocurrency for the long term, you can sell your coins on a drop day, realize the loss on tax, and buy them again immediately.
Long-term and short-term capital gains and losses
Another important factor when reporting cryptocurrency profits and losses is how long you have held the cryptocurrency.
Capital gains and losses are divided into two groups: short-term and long-term. Short-term capital gains or losses are assets held for less than one year. Long-term capital gains or losses are assets held for more than one year.
Long-term capital gains are taxed at lower rates than short-term gains.
Profits and losses offset each other, but this happens in several steps: first, short-term losses offset short-term gains; second, long-term losses offset long-term gains; and if losses remain, short-term losses offset long-term gains and vice versa.
Capital loss carryforward
If you still have losses after taking these steps, you can deduct the losses from your ordinary income. This deduction is limited to $3,000 per year, or $1,500 for married couples filing separately.
Any losses over $3,000 are split into short-term and long-term losses and carried forward to the following tax year. These losses can be offset against profits in the following year until they are used up.
How to declare cryptocurrency losses on taxes
Declaring cryptocurrency profits and losses for tax purposes requires several steps. Once you have your transaction data, including costs and revenues, follow these steps:
Step 1: Distinguish between the short and long term
When reporting profits and losses on your tax return, you will need to separate your transactions into short term and long term. From there, you will group your transactions based on whether they were reported on a 1099-B or not. Currently, cryptocurrency exchanges do not issue 1099-Bs, so you will need to select the option that indicates this.
Step 2: Report on Form 8949
Once a transaction falls into these groups, it is reported on Form 8949. Each transaction must include the following information:
- Description (usually the quantity and coin, e.g. “.012 BTC”)
- Acquisition date
- Disposal date
- Revenue (sales price)
- Cost basis
In the last column, subtract the cost from the revenue to calculate the profit or loss. The total for all transactions appears at the bottom of each 8949.
Step 3: Schedule D and Form 1040
The totals for each 8949 are then rolled up into a Schedule D, which offsets short-term and long-term gains. It also includes past capital losses and determines whether you can carry them forward to the next tax year. The end result, whether a gain or loss, is reflected on Form 1040.
Cancelling worthless cryptocurrencies
Did you buy any coins that went bust this year? If the coins still have some value, you can sell them and claim the loss on your taxes. But if the coins have gone completely worthless and are no longer trading on any exchanges, you're out of luck.
At that time, cryptocurrencies will be declared worthless in the eyes of the IRS.
Typically, capital assets such as stocks can be deducted in the year they are declared worthless. However, as we explained earlier, cryptocurrencies are considered property rather than capital assets.
This means that if cryptocurrencies are determined to be worthless, they will not be treated like regular investment losses. Instead, they will be treated as miscellaneous itemized deductions. Miscellaneous itemized deductions have not been allowed since the Tax Cuts and Jobs Act of 2017.
However, this law is set to expire at the end of 2025, so this tax treatment may change in the future.
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Other IRS Reporting Requirements for Cryptocurrencies
In an effort to crack down on unreported cryptocurrency transactions, the IRS added a digital asset question to Form 1040, which requires you to disclose whether you received or disposed of any digital assets during the year.
Cryptocurrency received as payment for services is taxed as income. Cryptocurrency gifted to another individual may need to be reported on a gift tax return depending on its value. For 2023, gifts of less than $17,000 are not subject to gift tax reporting.
While it's better to sell your cryptocurrencies when they have increased in value, these tax benefits can make selling at a loss a little less painful. If you still need tax assistance sorting out your crypto losses, consult with a tax accountant who specializes in cryptocurrencies. IRS guidance and regulations have been updated frequently over the past few years and are likely to continue to evolve in the future.
