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Understanding Crypto Losses and Your Taxes

If you experienced losses in cryptocurrency during 2022, you’re not alone. The industry faced significant downturns, with losses amounting to nearly $1.4 trillion. However, there might be a silver lining: you could potentially deduct these losses from your federal income tax. Your eligibility to do so depends on the nature of your loss and the duration of your crypto holdings. Read on to learn more.

How to Report Crypto Losses on Your Taxes

The IRS treats cryptocurrencies as capital assets, similar to investment securities and real estate. When you sell a cryptocurrency for less than you paid, you incur a capital loss, which may be deductible. The most straightforward way to dispose of a cryptocurrency is to sell it for real currency, such as U.S. dollars. Using cryptocurrency to buy goods, services, or other forms of crypto is also considered a disposal.

Note that you can only claim capital losses or gains that are realized through the disposal of cryptocurrency. If your cryptocurrency’s value dropped before you could sell it, that’s not considered a capital loss. If the crypto issuer is working to revive the currency’s value, or it remains listed on at least one exchange, you haven’t realized a loss and cannot claim one on your income tax return.

Calculating Capital Losses

To calculate capital gains or losses on cryptocurrency when you sell or spend it, you must deduct its market value in U.S. dollars on the date of disposal from its adjusted cost basis on the day you acquired it. Adjusted cost basis includes the fair market value of the cryptocurrency on the day of acquisition plus any fees associated with acquiring it.

Long-Term vs. Short-Term Gains and Losses

U.S. tax law distinguishes between long-term and short-term capital gains and losses. If you sell cryptocurrency within one year of acquiring it, your gains are considered short-term and are taxed at the same rate as your regular income. Long-term gains, from assets held for more than a year, are taxed at a lower capital-gains rate.

Cost-Basis Methods

If you sell a portion of a cryptocurrency holding acquired over time, the IRS allows several methods to determine the cost basis:

• FIFO (first-in, first-out): Uses the cost basis of the oldest batch of cryptocurrency tokens.
• LIFO (last-in, first-out): Uses the cost basis of the most recently purchased tokens.
• HIFO (highest-in, first-out): Uses the cost of the most expensive portion of tokens.

HIFO generally provides the best method to reduce your tax liability, but another method might be more suitable depending on your investment transactions. Consult an accountant or tax expert if in doubt.

Claiming Abandonment Loss

If a cryptocurrency is rendered worthless, you may be able to claim a loss through abandonment. Document the value of the cryptocurrency at acquisition, declare your intention to discard it, and send it to a null address to prevent future trades.

Reporting Crypto Losses on Your Taxes

To report cryptocurrency losses and gains, use IRS Form 8949 and Schedule D of IRS Form 1040. If you received a Form 1099-B from an exchange, check whether the cost basis was reported to the IRS. Document the date of acquisition, cost basis, date of disposal, and amount sold for any other transactions.

Can Crypto Losses Offset Stock Gains?

Yes, cryptocurrency losses can offset gains from the sale of any capital asset, including stocks and real estate. If your capital losses exceed your gains, you can use them to reduce your taxable income, up to an annual cap of $3,000 ($1,500 if married filing separately).

If you have both long-term and short-term capital gains, the IRS requires you to first use short-term losses to offset short-term gains and long-term losses to offset long-term gains. Any remaining net loss can then be used to offset gains in the other category and reduce your taxable income.

The Bottom Line

If you suffered crypto losses in 2022, you might be able to offset your tax burden. Reporting and claiming these losses can be complex, especially with determining and documenting the cost basis of your holdings. If you feel overwhelmed, consider seeking advice from a tax professional with crypto experience.

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