Bitcoin Losses Taxes: The Ins & Outs

In 2021, cryptocurrencies such as Bitcoin and Ethereum rose to all-time highs. Those who invested before 2021 enjoyed great returns. The situation has changed in 2022, though. 

The world's second most valuable cryptocurrency, Ethereum (ETH-USD), plummeted in value by 20% overnight before recovering by Friday afternoon to trade at $2,070. As a result, several major cryptocurrencies have lost value due to fear of investors withdrawing their money.

The value of cryptocurrencies has taken a hit, which means you might lose money if you sell your assets. Nevertheless, investors must still pay their taxes. 

The Internal Revenue Service (IRS) is intensifying its efforts to enforce tax laws, so even currency holders — not to mention traders — should be careful not to break the law. But here’s some good news. 

US crypto asset investors can deduct losses from current or future gains by reporting losses to the tax authorities.

Soon, you will find the ins and outs of Bitcoin losses taxes and how you can leverage them to lower your tax burden. But first, it’s important to familiarize yourself with crypto tax laws.

How Is Crypto Taxed?

Cryptocurrencies are generally taxed as property and investments, not as currency. As a result, all cryptocurrency trades and exchanges are taxed similarly to other capital gains and losses.

When dealing in cryptocurrencies, you need to note how much you earned or lost in US dollars for each transaction. You will be able to report your cryptocurrency gains and losses more precisely that way.

Whether you owe taxes in 2022 will be determined by the way you use your crypto. Capital Gains Tax will be due whenever you dispose of crypto. In the US, you can cash out your cryptocurrency in three major ways:

• Buying crypto and selling it for fiat.
• Buying and selling digital assets for digital assets.
• Cryptocurrency used for purchasing products and services.

Cryptocurrency mining and receiving it in exchange for goods and services can also result in tax owed. In such cases, you pay income tax at your ordinary rates, according to the value of the crypto at the time of receipt. 

Your Federal Income Tax bracket determines how much you pay when you sell a crypto asset you've held for less than a year(short-term gains). Your crypto tax rate will range from 10% to 37% based on your income.

Examples of Non-Taxable Events

Taxes on income and capital gains do not apply to the following crypto transactions.

• Buying crypto with fiat money.
• Cryptocurrency holdings.
• Cryptocurrency transfers between your own wallets.
• Crypto gifts (maximum $15,000 for one gift and one recipient).
• Cryptocurrency donations (tax-deductible).

Taking Advantage of Losses

The loss you suffer when you sell cryptocurrency at a lower price than when you purchased it is a capital loss. It is possible to turn losses into wins on your tax return if you know how to handle them properly. 

The Internal Revenue Service allows investors to offset gains with losses on stocks and other types of investments, such as cryptocurrency. 

You can offset your crypto losses with gains from other cryptos or stocks using a technique known as tax-loss harvesting.

Losses that exceed gains in a year can be deducted against taxable income up to $3,000 per year. Losses over $3,000 can be carried over every year until death to offset gains in future years.

How Do Losses Apply?

It is important that you check your eligibility before getting too excited about the idea of tax-loss harvesting.

Here’s the catch. Taking the capital loss requires actually selling the investment; the investment cannot just be written off as a loss.

There are many types of disposals, including the three we mentioned above.

In addition, tax-loss harvesting is only available in taxable investment accounts. When you own cryptocurrency through a self-directed IRA, tax-loss harvesting is not available to you. 

Another thing to keep in mind is that short-term capital losses are offset first by short-term capital gains, while long-term capital losses are offset first by long-term capital gains. Whenever you have net capital losses left, you can use them to offset other kinds of capital gains.

I Have Lost Crypto Assets. Can I Claim Losses?

Well, no.

You may have lost your key, and it’s a well-known fact that cryptocurrencies cannot be accessed if you lose your private key. Though you no longer have access to the private key, the key still exists. Also, cryptocurrency still exists in distributed ledgers. 

In 2018 the IRS announced the only losses that could be deducted on Form 4686 ( Losses and Thefts) were assets destroyed in catastrophes declared by the federal government.

Unfortunately, there is no definite procedure for claiming the loss of crypto if you no longer possess the crypto key. Therefore, you will not be able to claim a loss as disposal under Capital Gains Tax if you lose your key. 

Calculating A Loss

After determining whether you are eligible for tax-loss harvesting or not, it’s time to calculate those losses.

When you calculate your crypto capital loss, you use the same procedure as you would for your crypto gains: Earnings - cost basis = capital loss.

In calculating your loss, you can deduct a number of expenses. These include:

1. Fiat currency originally used to purchase cryptocurrencies.
2. Transaction charges paid prior to adding a transaction to the blockchain.
3. An exchanged cryptocurrency's base cost. 
4. Spending on advertising for either a buyer or a seller.
5. Costs associated with calculating gains and losses through valuation or apportionment. An example would be the cost of a software subscription that enables you to calculate profits and losses.
6. Contract preparation fees associated with cryptocurrency acquisitions or disposals. 

These circumstances, however, prevent you from claiming mining expenses (e.g., equipment).

To determine if you have overall losses or gains, you must calculate and report individual transactions, as well as your total losses and gains. Generally, you can carry forward losses for future tax years if you have all-around losses.

Crypto Loss Harvesting - The Wash Sale Rule

Loss harvesting is the practice of tactically selling assets at a loss to offset profits. 

The purpose of tax harvesting is usually to offset capital gains. However, even without gains, you might still want to take advantage of losses so that you can lower your taxes and offset other types of gains, like stocks.

Buying and selling a crypto asset within 30 days is considered a crypto wash sale, which is illegal for certain investors.

Wash sales are prohibited for stocks and other types of securities. However, since cryptocurrency does not qualify as a security, they are legal and permissible.

In other words, you can dispose of crypto after it has fallen in value, secure the loss, and then repurchase it afterward. It's not a perfect solution — crypto traders have been doing this for a long time, and the IRS may be trying to recoup some of that revenue. 

In fact, lawmakers and regulators have expressed an interest in extending the rule to cryptocurrency.

To harvest losses, just like we previously explained, your organization could take advantage of another tax provision requiring transactions to have enough economic weight to qualify for tax benefits, says Rochester accountant Matt Metras.

To put it another way, there has to be some sort of risk involved in the market for you to buy the same coin again.

It's best to let 30 days pass, similar to stocks, before purchasing again to be on the safe side. However, some accountants believe that your case would be stronger in a shorter period of time if you were willing to take on some market risk, as cryptocurrencies are volatile.

How to Report Bitcoin Losses Taxes To The IRS

Crypto losses can and should be claimed on your tax files. Tax deductions for crypto losses are important for two main reasons:

1. The IRS mandates reporting of all crypto sales since it considers cryptocurrencies as property.
2. It is possible to use crypto losses as an offset for capital losses (even future ones) for a maximum deduction of $3,000 per year.

Crypto losses should be reported on Form 8949 and 1040 Schedule D.

Tax Form 8949 records every sale of crypto during the tax year. The IRS Form 8949 also lets you list crypto capital gains and losses. Your calculations will then need to be organized row-by-row, with transaction details included. 

Keep a record of the following details so you won’t hate yourself once the tax season arrives. 

• Property Description
• The date of acquisition (MM/DD/YYYY)
• The date it was sold
• Cost basis
• Changes 
• Gains or losses

When you file your taxes, you need to report non-crypto investments on separate Form 8949s.

Gains and losses for both long- and short-term periods are reported on Schedule D of Form 1040. You can also add losses carried over from last year here.

With increasing trade volume and/or missing cost bases, calculating crypto gains and losses becomes more challenging. When this is the case, crypto tax software is a fantastic tool to have.

Other Methods to Avoid Paying Bitcoin Taxes

A while ago, we published an article discussing how you could avoid paying taxes on Bitcoin. 

Of Course, you can't avoid paying taxes on your crypto except by not using it. Taxes will eventually be due upon sale, transfer, fiat conversion, exchange, or trading - when the value of your crypto increases.

But, there are definitely legal and beneficial strategies to minimize the amount you have to pay by year's end. Here are some legal methods to lower your tax burden.

Use An IRA Account

Investing in cryptocurrency may be tax-advantageous if you purchase it in a self-directed Individual Retirement Account (IRA). Self-directed IRAs enable you to invest in a wide range of assets, including cryptocurrencies and precious metals.

Such accounts let investors put their retirement savings in stocks, bonds, commodities, and cryptocurrencies.

Give Crypto Gifts

There are tax benefits associated with cryptocurrency gifts. When you give cryptocurrency as a gift, there is no tax liability for you. Generally, gifts worth more than $15,000 require a gift tax return, which serves primarily as an informational document. 

To determine the tax they owe at the time they decide to sell the cryptocurrency, the recipient of the cryptocurrency must know your basis. They'll have to pay tax for gains over the basis, but it might not be as much as if they paid it themselves.

Reducing Taxable Income

Another effective tax reduction method is lowering taxable income. To do this, you will need to search the tax code for deductions and credits that can lower your tax bill. That’s a heroic feat, of course, that not everyone feels like doing. 

Thankfully, Lorenzo Tax crypto tax professionals have all the knowledge investors may need to lower their income.

Move to Another State

As extreme as it may seem, there are some investors who relocate to regions with lower tax rates. You can read about the details of relocating to another state or country in our blog post: Can I Avoid Paying Taxes on Bitcoin?

Donate to Charity

Similarly to gifting appreciated crypto to a loved one, you can also donate cryptocurrency to charity. This will not only result in no capital gains tax, but you may also be able to claim a significant tax deduction after charitable crypto donations.

When you sell your cryptocurrency, you are generally able to deduct its fair market value, but you are not liable for capital gains taxes.

Deduction amounts are limited, so consult your tax advisor about how a donation may benefit you.

Hold On to Your Assets 

Cryptocurrency may eventually need to be sold. Don't sell cryptocurrency unless you've held it for over a year to lower your tax burden. Depending on whether it qualifies as long-term capital gains, you might be able to avoid paying taxes on it. 

Have you read all the way through? 

Good. Because it’s now time for a crypto accountant-level secret to working your way around the $3000 caps rule.

Here's an Insider's Tip That Will Help You Save More Than $3000

It is possible to work around the $3,000 threshold for those who are professional traders, but they must follow certain rules.

A person may qualify for alternative tax status if they satisfy the requirements as a "trader in securities." Such investors need to make money off short-term marketplace fluctuations rather than from other sources (like mining or holding assets for profit).

What Is This "Trader Status" All About? 

Trading activities can be taxed differently if you qualify for trader status and choose to report your income as such.

Trader tax status has several advantages, one of which is that interest can be deducted as an expense. It is possible for traders to deduct educational costs, like seminar fees and course materials, as long as they are separate and exceed two percent of their taxable income.

Aside from this, day traders without trader tax status can only deduct up to $3,000 in losses on their taxes, while those with mark-to-market rights can deduct more.

However, if you’ve made gains with the trader status, you’ll have to pay short-term tax no matter how long you held them. Therefore, they will be subject to ordinary income tax rates, higher than those on long-term investments.

Traders can also make what is known as a Section 475(f) decision. As a result, their trading activity is reported according to "mark-to-market" guidelines. 

Consequently, any open shares are reported as though they were disposed of at the end of the year and repurchased at the beginning of the following year.

Crypto Tax Advisor & Consultant

Our discussion has just covered the highlights of Bitcoin losses taxes. But as you know, there are many variables and potential implications to consider when it comes to tax-related matters.

Maintaining a record of your cryptocurrency investments and reporting them on your taxes can be quite tedious, especially if you trade on a regular basis. The right capital loss planning enables you to take advantage of losses as soon as possible and without wasting time.

In the end, crypto exchange platforms like Coinbase and Binance can’t always be trusted to provide gains and losses data to their users. It is because of the complexity of cryptocurrencies and their integration that this problem occurs. 

It is up to you and your crypto tax advisor to decide how much or how little loss you wish to harvest. Moreover, an experienced financial advisor can help you strategize your next moves in the market.

We strongly recommend that you get in touch with Lorenzo Tax financial professionals, who can walk you through your options.

Conclusion

It is necessary to make a crypto taxable event on the asset for a loss to be realized - either by selling it, exchanging it, or spending it. If not, the loss cannot be realized and, therefore, cannot be reported to the IRS.

No matter how your assets perform together, you can offset virtual currency losses with other capital gains, either in the current year or in future years.

Crypto tax loss harvesting allows you to identify unsold assets with losses before the end of the tax year. As an example, if you have invested in many ICOs, selling some coins may allow you to claim a loss.

For more info on crypto tax basics, make sure you check the Bitcoin Losses Taxes blog post on the Lorenzo Tax website.

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