Understanding Crypto Losses and Your Taxes

If you experienced losses in cryptocurrency investments in 2022, you’re not alone. The crypto industry faced significant downturns, with losses amounting to nearly $1.4 trillion due to the collapse of exchanges and other financial entities. However, there is a silver lining: you may be able to deduct these losses from your federal income tax. This article will guide you through the process of reporting crypto losses on your taxes and how they can potentially offset stock gains.

What to Know About Crypto Losses and Your Taxes

The IRS treats cryptocurrencies as capital assets, similar to investment securities and real estate. When you profit from selling a capital asset, the proceeds are considered capital gains and are subject to tax. Conversely, if you sell a capital asset for less than you paid for it, you incur a capital loss, which may be deductible from your taxes.

The most straightforward way to dispose of 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 disposal. When you spend crypto, you must calculate any capital gains or losses from the time you acquired the crypto to when you used it as payment.

It’s important to note that you can only claim capital losses or gains that are realized through the process of disposing 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 the 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 is the fair market value of the cryptocurrency on the day of acquisition, plus any fees associated with acquiring it. This formula applies whether you purchased the cryptocurrency, received it as payment, or obtained it by mining.

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 less than one year from the day after you acquire it, your capital gains are considered short-term. If the holding period is one year or longer, proceeds from its sale are considered long-term gains or losses.

Short-term capital gains on cryptocurrency sold during 2022 are considered part of your regular income and are taxed at the same rate as your wages or salary, which can range from 10% to 37%, depending on your income level and tax bracket. Long-term cryptocurrency gains are taxed at a lower capital-gains rate, which can range from 0% to 20%, again depending on your bracket.

Cost-Basis Basics

If you sell a portion of a cryptocurrency holding you acquired over a span of time or in multiple transactions, the IRS permits you to use any of several methods to determine the cost basis used to calculate losses or gains:

• FIFO (first-in, first out): Uses the cost basis of the oldest batch of cryptocurrency tokens sufficient to satisfy the trade.
• LIFO (last-in, first out): Uses the cost basis of the most recently purchased tokens sufficient to meet the sale.
• HIFO (highest-in, first out): Uses the cost of the most expensive portion of tokens in your holdings as the cost basis.

To illustrate, let’s imagine you purchased one Examplium token during each quarter of 2020, paying $1,000 in January, $1,200 in April, $1,800 in July, and $1,500 in October. If you sold one Examplium token in 2022 for $200, calculating your capital loss using the different cost basis approaches would affect the loss you could declare on your tax return:

• FIFO: Uses the January price of $1,000 as cost basis, yielding a capital loss of $200.
• LIFO: Uses the October price of $1,500 as cost basis, yielding a capital loss of $1,300.
• HIFO: Uses the July price of $1,800, yielding a capital loss of $1,500.

HIFO generally provides the best cost-basis method to use when trying to reduce your tax liability, but another method might make more sense for you if you have complicated investment transactions at play. If in doubt, consult an accountant or other tax expert.

You must apply the same method to all transactions reported within a given tax year, and you must be able to document the dates and prices of all cryptocurrency transactions to use LIFO or HIFO. If you cannot document the market value of cryptocurrency on the date you obtained it, you must use $0 as your cost basis, which means treating all proceeds from any sale as capital gain.

Claiming Abandonment Loss

The IRS allows you to claim the loss of a cryptocurrency that’s been rendered valueless—that is, it has zero market value and is not listed on any exchange—through a process known as abandonment. To do so, you must document the value of the cryptocurrency at the time you acquired it, declare your intention to discard the cryptocurrency, and then discard it by sending it to a null address to prevent any future trades.

How to Report Crypto Losses on Your Taxes

The process for reporting cryptocurrency losses and gains on your tax return is comparable to that of reporting gains or losses on other assets.

If any of your 2022 cryptocurrency trades were conducted by an exchange that sent you a Form 1099-B, check each form to determine whether the cost basis for the transactions was reported to the IRS. Keep 1099-B’s that reported cost basis separate from those that didn’t.

For any other crypto transactions that led to a loss or a gain but didn’t generate a Form 1099-B, document:

• The date you acquired the cryptocurrency
• Your cost basis (the amount you paid plus any transaction fees, in U.S. dollars); if you cannot document this, you may have to use a cost basis of $0
• The date you disposed of the cryptocurrency
• The amount you sold it for, in U.S. dollars (or, if you used it as payment, its market value in dollars on the date you spent it)

Detail the cryptocurrency transactions that generated losses or gains using IRS Form 8949. Use separate instances of the form for:

• Trades that generated a Form 1099-B and reported the cost basis to the IRS (check Box A for short-term transactions and Box E for long-term transactions)
• Trades that generated a Form 1099-B but did not report cost basis to the IRS (check Box B for short-term transactions and Box D for long-term transactions)
• Trades that did not generate a Form 1099-B (check Box C for short-term transactions and Box E for long-term transactions)

Enter the net gains and losses calculated using Form(s) 8949 on Schedule D of IRS Form 1040. Enter short-term losses or gains in Part I of Schedule D; long-term losses or gains are entered in Part II. Each section has separate lines for entering totals from Forms 8949, according to the applicable checkboxes used:

• Use line 1b for short-term capital gains or losses listed on Form 8949 with checkbox A selected.
• Use line 2 for short-term capital gains or losses listed on Form 8949 with checkbox B selected.
• Use line 3 for short-term capital gains or losses listed on Form 8949 with checkbox C selected.
• Use line 8b for long-term capital gains or losses listed on Form 8949 with checkbox D selected.
• Use line 9 for long-term capital gains or losses listed on Form 8949 with checkbox E selected.
• Use line 10 for long-term capital gains or losses listed on Form 8949 with checkbox F selected.

If you are claiming an abandonment loss on a delisted, worthless cryptocurrency you have discarded, enter the amount of the loss using IRS Form 4797, Line 10.

Can Crypto Losses Offset Stock Gains?

Yes, cryptocurrency losses can be used to offset taxes on gains from the sale of any capital asset, including stocks, real estate, and even other cryptocurrency sold at a profit.

In fact, if your capital losses exceed your capital gains, you may even be able to use them to reduce your taxable income, further lowering your tax bill.

In a simple example that ignores fees for the sake of round numbers, let’s say that, in 2020, you bought $2,000 worth of shares in XYZ Corp. and $1,000 in Examplium cryptocurrency. Two years later, in 2022, you sold the stock for $2,800 and the cryptocurrency for $100.

Crypto Losses vs. Stock Gains

You’ve realized a $700 long-term capital gain on the stock and an $800 long-term capital loss on the cryptocurrency. If those are your only capital gains or losses for the year, you’ll see a net capital loss of $100.

That means you are exempt from capital gains taxes for the year. What’s more, the IRS allows you to deduct net capital losses, up to an annual cap of $3,000 ($1,500 if you’re married but filing separately), from your personal income, so you also can reduce your taxable income by $100.

The situation becomes more complicated if you have both long-term and short-term capital gains in the same year. The IRS allows you to use all capital losses to offset capital gains but requires you to first use short-term losses to offset short-term gains and long-term losses to offset long-term gains. If there’s still a net loss in either category, then and only then can it be used to offset remaining gains in the other. If there’s still a net loss after all gains have been accounted for, you can use the remaining loss to lower your taxable income, up to the $3,000 limit.

To illustrate, let’s look at an example that builds on the long-term-only scenario discussed above, once again ignoring fees and using round numbers for simplicity:

In addition to selling your XYZ stock and the long-term Examplium holding, let’s say you sold off two smaller batches of Examplium, purchased in late 2021, just as the crypto market began to crater in early 2022.

Additional Crypto Transactions

As before, your long-term gains and losses add up to a net loss of $100.

Your short-term net is calculated by adding the $300 gain on Examplium 2 crypto to the $100 loss on Examplium 3, for a net short-term gain of $200.

Once you’ve calculated net long-term and short-term capital gains, you can use any net loss in either category to offset net gains in the other. So, using your $100 long-term net loss to offset the $200 net short-term gain leaves you with a net short-term capital gain of $100, which would be taxable as regular income for the 2022 tax year.

The Bottom Line

If you suffered crypto losses in 2022, there may be some consolation in the ability of losses from any trades to offset your tax burden for the year. Reporting and claiming capital losses or gains associated with cryptocurrency trades can be tricky, particularly with respect to determining and documenting the cost basis of your holdings. Tokens moved among wallets and trades that exchange one crypto token type for another can make it hard to pinpoint acquisition costs unless you keep careful records. If you start to feel overwhelmed (and even if you don’t), it can be smart to seek the advice of a tax pro with crypto experience.

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