Bitcoin Losses Taxes: Essentials You Should Know

Have you lost money on crypto trades this year? We think you should know these two things:

1. You’re not alone.
2. You can save thousands of dollars on your tax bill. 

By claiming deductions and offsetting your income against your crypto losses, you may be able to reduce your tax bill. Of course, those are just two of the methods we’ve discussed here below.

Our guide on Bitcoin losses taxes will provide you with all the information you need and help you calculate your losses.

Let’s start with one of the most googled questions:

Do I Have to Pay Taxes on Crypto?

Well, yes.

Instead of categorizing crypto as a currency, the Internal Revenue Service (IRS) considers it a type of property. Bitcoin must be taxed at its current value if you receive it as payment. If you sell it for a profit, the difference between the purchase price and the sale proceeds of a cryptocurrency is subject to taxation.

Your personal circumstances will determine how crypto taxes are calculated (e.g., ordinary income tax is higher than capital gains’ taxation).

There’s only one scenario in which you don’t have to pay taxes or report to IRS: 

According to IRS guidance listed on your Form 1040 tax return, you aren’t required to pay any taxes or report to IRS if you only bought cryptocurrency using fiat (in this case, US dollar) and didn’t sell it.

But you have to report your gains and pay taxes on them if you:

• Bought and sold cryptocurrencies like Bitcoin (with an increase in price from when you bought it)
• Trade crypto for a living
• Exchange cryptocurrencies like Bitcoin for goods, services, amenities, etc.

This makes sense, and most investors find it manageable to file and pay their crypto taxes accordingly. Or at least, that’s how it used to be before the 2022 losses happened.

How Does the Crypto Market Look for Investors?

There was a lot of activity in the crypto space in 2021. First-time investors poured into the market during this year. Approximately half of the current Bitcoin investors started purchasing in the last 12 months, according to a Grayscale Investments study. 

Throughout the year, the crypto market reached multiple all-time highs and lows, resulting in substantial capital gains and losses. 

But crypto markets have fallen around 50% in the past month and lost over 70% from their previous peak in late 2021. There are many crypto investors looking for solutions after their gains from the last few years have vanished into thin air.

Yes, your upcoming tax season may find you facing losses rather than gains. But, not all hope is lost!

Bitcoin Losses Taxes - 6 Hacks for Investors

The US Internal Revenue Service allows cryptocurrency investors to claim deductions from their losses. In some cases, this can result in a reduction in tax liability or even a tax refund. Other investment strategies can also help you maximize your losses and benefit from your crypto investments all year long.

Remember that no matter which strategy you choose, it must be done before the end of the financial year to reduce your tax bill.

#1 Capital Gains Offset

It is possible to offset capital gains with cryptocurrency losses. Selling, transferring, or otherwise disposing of your crypto for a profit is considered a capital gain.

Depending on how long you've held your crypto, you'll pay different taxes on capital gains.

Whenever you have both short- and long-term capital gains on the same asset, you should first harvest your short-term capital losses to offset your short-term gains, which have a greater tax burden.

#2 Harvest Your Losses

Bitcoin and cryptocurrency market dips are exploited for tax-loss harvesting. 

Using tax-loss harvesting, you can take advantage of capital losses by selling your assets at a loss. It is possible to carry forward capital losses against future capital gains and even over several financial years if necessary.

For example, if you made $10,000 after buying and selling Ether but lost $10,000 after selling your Luna, you won’t owe any tax. Likewise, you can offset losses from crypto trading with gains from share trading.

The purpose of this method is to incur capital losses by selling crypto or other digital assets when the fair market value drops below the cost basis. As explained above, you can continue to deduct those losses from capital gains to reduce your Bitcoin losses taxes. 

But watch out for wash sale rules! 

What is The Wash Sale Rule?

According to the wash-sale rule, an investment that is sold at a loss and then bought back within 30 days cannot claim the initial loss.

In essence, this rule prohibits selling assets at a loss and then promptly repurchasing them to cause an artificial loss. The best way to avoid this is to swap one cryptocurrency for another or sell and buy a different one.

To sum this rule up:

• Having lost money on the stock, you decide to sell it.
• You cannot purchase a "substantially identical" crypto stock within 30 days of selling it if you wish to harvest the loss.

We’ll touch on the vague “substantially identical” term later in this blog. Before that, there’s good news on the horizon. 

Update (Good News) on Was-Sale Rule

Since December 2021, the "wash sale" law only pertains to stock and securities, not cryptocurrency. You remember that according to the IRS, digital currency is property, not security. 

Clearly, this means:

If you sold cryptocurrency you owned at a loss, you could repurchase the same cryptocurrency without observing any delay time between transactions. Accordingly, you could deduct capital losses or capital gains on your tax return.

Using this method has its advantages, but there are some drawbacks as well. 

Cryptocurrencies are not securities and are therefore not subject to this rule. However, stocks and funds related to cryptocurrency are not included. This brings up a new question.

Is There A Safer Way to Harvest Crypto Losses?

In the future, cryptocurrency could be subject to wash sale regulations. It is likely that broader regulations will be introduced for both cryptocurrency and initial coin offerings (ICOs) by the Securities and Exchange Commission (SEC).

The importance of understanding how to avoid wash sale rule violations remains regardless of whether a crypto wash sale rule exists or not. Unless you understand and abide by this rule, your efforts to minimize taxes with loss harvesting will be in vain.

If you want to avoid a wash sale, you can trade the declining asset for a coin that is closely associated with its price. Following that, you would hold the correlated coin for over 30 days before repurchasing the initial asset.

What would we suggest?

You should use your common sense when dealing with cryptocurrency and particularly IRS regulations regarding wash sales. Don't take chances when you're not sure.

For guidance on which assets you can buy after selling securities to avoid violating wash sale rules, talk to a financial advisor. 

#3 Claim A Deduction

Not a single gain? Make a claim for a deduction.

As long as you don't have any capital gains to offset, you can subtract up to $3,000 in capital losses off your normal income (according to 26 US Code § 1211 of the Internal Revenue Code). 

Any losses that exceed this annual limit will be carried over to the next year.

Let’s Talk More about the $3,000 limitation on capital losses.

As you just read, the IRS allows you to deduct a maximum of $3,000 in capital losses every year to offset your taxable income.

When you have a net capital loss of more than $3,000 during a tax year, you may be able to carry over the excess losses to the next year. In a future tax year, you can offset losses against cap gains or claim an additional deduction.

The more capital gains you shelter faster, the more tax benefit you will receive from the capital loss. You might as well keep your position and wait for a gain at some point in the future if you have no gains to look forward to.

You could also report an “abandonment loss” in some cases, which brings down your total owed tax to 0!

Abandonment Loss

Earlier this month, a heated discussion broke out on Twitter about whether crypto investors would be affected by the government's capital loss limitations, which cap taxpayer losses at $3,000 for a single financial year, with leftover losses allowed to be rolled into the following year.

Here’s a summary of what we learned from the whole debate:

As soon as tokens become “worthless”, investors can take advantage of federal abandonment loss provisions to write off the entire loss. Your investment is then called a “worthless” one when the asset’s value drops to 0.

An abandonment loss is a reduction in profits caused by: 

1. The abrupt end of the operation of a project, or 
2. A Business deal that is abandoned for good. 

When a taxpayer sustains such losses during a taxable year, he or she is entitled to a full deduction.

The abandonment loss provision is a controversial one, and many field experts have already advised against its use for most cryptocurrency investors.

We recommend that you contact a professional crypto CPA to discuss this matter more before deciding whether you should do it or not.

#4 Donate Crypto

A crypto donation to a non-profit or charitable institution approved by the IRS is not subject to capital gains taxes and can, in some cases, be excluded from your taxes.

Suppose you bought $40,000 of Bitcoin and later (after 12 months or more) sold it for $70,000. The $30,000 profit you made would typically be subject to long-term capital gains tax.

Donating an asset, however, will not entail capital gains taxes provided you meet the following requirements: 

• The donated cryptocurrency has been in your possession for more than a year 
• You’ve checked with the IRS to see if the intended recipient is a tax-exempt organization
• Rather than cashing out or converting the cryptocurrency, you hand it over in its entirety to the organization.

#5 Don’t Sell

You can only ensure you won’t be taxed on your crypto by merely holding it. 

According to some jurisdictions, long-term capital gains can be realized after holding crypto investments (or other assets such as shares) for more than a year. If you didn’t already know, long-term capital gains:

• Are free of tax in Germany.
• Provide capital gains tax discounts of 50% by 50% in Australia.
• Taxed at a lower rate of 0%, 15% or 20% in the US, depending on how much an individual earns during a financial year.

The collateral you put up to borrow cryptocurrency is not taxable if you need to use your investments to make ends meet.

Note: If you are forced to liquidate your business, you will owe taxes.

#6 Speak with A Financial Advisor 

To stay on top of the latest trends, consider hiring a professional public accountant.

A financial advisor could help you figure out: 

• The potential tax implications of owning and trading cryptocurrency
• What the extension of wash sale rules could mean for you
• The latest crypto market news (regulations, forms, etc.)

Check Lorenzo Tax services to learn more.

Calculating Crypto Losses

You’ve probably encountered the term “Bitcoin losses taxes” more than enough on this blog post. But do you know how your losses are calculated?

1. Make a list of all your long-term gains and losses, including those on non-crypto investments
2. Then, determine the sum of your short-term gains and losses, including those from non-crypto assets
3. Calculate the combined total of your long-term and short-term capital gains and losses to arrive at your final capital gains or losses

The IRS Wants to Know about My Losses, Do I Have to Report Them?

Yes, you have to report any crypto losses on IRS Form 8949. 

Actually, we strongly recommend that everyone who has suffered a loss report it to the IRS, no matter how small it may be.

There's a common misconception that investors don't have to report their losses to the IRS if they merely suffer losses. Unfortunately, this isn't true, and IRS regulations state that cryptocurrency losses should be reported on your taxes.

Overall, the IRS probably knows anyway, as there’s no such thing as “anonymous” investors or traders. But you’d better report them before the new financial year begins, or there’ll be consequences.

Can I Write Off Lost Or Stolen Cryptocurrency? 

There are times when investors lose cryptocurrency following certain circumstances, such as a cyberattack or a lost wallet key. However, these types of accident and theft losses are not deductible after the Tax Cuts and Jobs Act of 2017 anymore. 

Now back to the fairly vague term we mentioned above.

What Does “Substantially Identical” Mean?

What does it even mean to be substantially identical?

The IRS gives no clear-cut definition. Instead, investors are left mostly on their own to figure out what substantially identical means. That’s how the tax-loss harvesting process becomes more complicated as there is more gray area to navigate. 

Conclusion 

Don't let cryptocurrency losses get you down. There will always be losses for investors. Think of how you can turn those losses into profits and apply your newly gained insight to future crypto investments.

Investors who suffer crypto losses can claim deductions that reduce their tax liability or even result in a tax refund. That strategy - which is only one of the six other strategies we discussed above - will help you reduce your Bitcoin losses taxes.

Remember that cryptocurrencies can make an interesting addition to your portfolio, but you should do your best to balance your investments with other assets. You can use our expert team of crypto financial advisors’ help! 

Book a call today, and we’ll answer your questions and give you the crypto tax consultation you need.