Learn the IRS rules and act fast, and you could get a tax break for years to come to ease your pain.
Investors in Bitcoin and other digital assets have recently been ravaged by the longest losing streak since 2011. If you are, you might be happy to hear that there are ways to mitigate some of the sting of those losses: act fast and you can file your tax bill for April and beyond.
The Internal Revenue Service allows taxpayers to use losses in stocks and other investments, including crypto, to offset gains. If your losses exceed your total gains for the year, you can deduct up to $3,000 from your taxable income. Losses over $3,000 can be carried forward each year until death to offset gains in future years.
Here’s the problem: you have to actually sell the investment to take the capital loss; it can’t just have fallen in value on paper. But crypto investors are getting a special deal. Shareholders must follow the so-called wash-sale rule; if they sell a stock at a loss, they must wait 30 days before buying the same security again, otherwise it will not be eligible for deduction.
So far, the IRS has not said that the wash-sale rule applies to digital assets. (There was a provision included in the Build Back Better Act that would have made crypto investments subject to the rule, but it hissed.)
That means you can sell crypto that has fallen in value since you bought it, lock in the loss, and then instantly flip and buy it back. The move has its limits – the IRS knows that crypto investors have been doing this for years and may be looking for an opportunity to recoup that income. To do this, the agency could turn to another part of the tax code that requires transactions to have “economic substance” in order to qualify for tax breaks, according to Matt Metras, an accountant in Rochester, New York, who represents taxpayers. for the IRS. In other words, you should expose yourself to some sort of market risk before buying the same coin again.
The big question then is how long you have to wait with repurchase to be eligible for the deduction. The most conservative approach is to wait 30 days, just like you would with stocks, before buying again. But most of the accountants I spoke to argued that you could make a pretty compelling case in a shorter amount of time exposing yourself to market risk, given how volatile the crypto market is.
How much shorter is a guess. The IRS has not issued detailed crypto guidelines since 2019. Whether you wait 20 minutes or 20 days, it really comes down to personal risk tolerance: are the tax savings worth the potential pain and scrutiny of an audit?
Separately, there’s been some buzz lately about fully amortizing losses on coins that have been fully decimated, such as Luna, meaning you can deduct the total amount of losses from your taxable income without being subject to the annual limit of $ 3,000 .
That’s a no-no for most. To meet the IRS requirements to make a full depreciation of investments, the coin must be really worthless. Even if Luna is fueled up, it’s still worth something. And the creator has proposed a revival plan, so it’s possible it could become more valuable in the future. In addition, you must dispose of the asset completely to claim the full depreciation – you would have to send it to a burn wallet (which takes the coin out of circulation).
There is a workaround for the $3,000 limit for those who are full-time traders, provided they abide by certain rules. If you qualify for tax dealer status and make a special choice, you will make profits or losses at the end of the year, without actually selling anything. Losses can be fully deducted from taxable income. But beware, if you have had any winnings they will be taxed as short term gains no matter how long you hold them. That means they’ll have to deal with your regular income tax rates, which are higher than long-term capital gains rates, says Sharon Yip, a certified public accountant in Reston, Virginia.
If you plan to sell cryptocurrencies at a loss, make sure you know how long you’ve held your coins – anything below the one-year mark is considered a short-term loss of capital. Short-term losses will be used first to offset short-term gains and then long-term gains (and vice versa, with long-term losses offsetting long-term gains first before being applied to short-term gains).
Should I point out that you should never be afraid to pay higher rates for short-term gains so that you stick with a crypto investment longer than you’d like? Colby Cross, an accountant in Seattle, says he had a client who made a dazzling profit on Filecoin in less than a year, but worried about paying more tax if she sold it. If you think your coin is trading at an all-time high, don’t try to save a little on taxes, especially considering how fast crypto markets can spin, Cross warns.
Finally, bad news: if you’ve been scammed by a crypto scheme, there’s no more tax break after changes under the 2017 tax overhaul. Before the law, many fraud victims could write off their loss. Now they will be saddled with those losses, with no tax write-off to soften the blow.
Alexis Leondis is a Bloomberg Opinion columnist on personal finance. Previously, she oversaw tax coverage for Bloomberg News.