Can You Deduct Crypto Losses From Taxes?

The Internal Revenue Service (IRS) views cryptocurrency as property for tax purposes, not as a traditional currency. This classification means that digital asset transactions are subject to the same capital gains and losses rules as other property, like stocks or real estate. These losses can offset gains or, under specific conditions, reduce ordinary income. Accurate record-keeping is essential for reporting crypto activities and managing your tax liability.

How Cryptocurrency is Taxed

A “taxable event” for cryptocurrency occurs when you dispose of it. This includes selling cryptocurrency for fiat currency, such as US dollars. Exchanging one cryptocurrency for another, like trading Bitcoin for Ethereum, is also considered a taxable event.

Using cryptocurrency to purchase goods or services is another instance that triggers a taxable event. In such cases, the transaction is treated as if you sold the cryptocurrency for its fair market value and then used the proceeds to make the purchase.

Buying cryptocurrency with fiat currency and holding it is generally not a taxable event. Similarly, transferring cryptocurrency between wallets or accounts you own is not considered a taxable event. However, receiving cryptocurrency as income, such as through mining, staking rewards, or as payment for goods or services, is generally taxed as ordinary income at its fair market value when received.

Calculating Your Capital Gains and Losses

Calculating capital gains or losses requires understanding your cost basis and sale proceeds. Your cost basis is the original purchase price of the cryptocurrency, including any fees directly related to its acquisition. For example, if you bought Bitcoin for $10,000 and paid a $50 transaction fee, your cost basis for that Bitcoin would be $10,050.

A capital gain occurs when you sell or exchange cryptocurrency for more than its cost basis, while a capital loss results when you sell it for less. The actual gain or loss is calculated by subtracting your cost basis from the amount you received from the sale or exchange. For example, if you sold Bitcoin with a cost basis of $10,050 for $9,000, you would have a capital loss of $1,050.

Capital gains and losses are categorized as either short-term or long-term, depending on how long you held the asset. Short-term capital gains and losses apply to cryptocurrency held for one year or less, and these gains are taxed at your ordinary income tax rates, which can range from 10% to 37%.

Long-term capital gains and losses apply to cryptocurrency held for more than one year, and these gains are taxed at lower preferential rates of 0%, 15%, or 20%, depending on your income level.

The “wash sale rule,” which prevents investors from claiming a tax deduction for losses on a security sold and repurchased within 30 days, currently does not apply to cryptocurrency. This means that, for now, you can sell cryptocurrency at a loss to realize a deduction and immediately buy back the same asset, though legislative changes are anticipated to close this loophole.

Deducting Crypto Losses on Your Taxes

Capital losses can be used to offset capital gains. If you have a net capital loss (meaning your total capital losses exceed your total capital gains for the year), you can deduct a portion of this loss against your ordinary income. The rule allows individual taxpayers to deduct up to $3,000 of net capital losses against ordinary income annually. For married individuals filing separately, this limit is $1,500 each.

This deduction can significantly reduce your taxable income. For instance, if you have $5,000 in net capital losses from crypto and no capital gains, you can deduct $3,000 against your ordinary income for the current tax year. The remaining $2,000 in losses can be carried forward indefinitely to future tax years.

These carried-forward losses can then be used to offset capital gains in those future years or to deduct up to the annual $3,000 limit against ordinary income in subsequent years. This carryover provision allows taxpayers to utilize substantial losses over time.

Accurate record-keeping of all cryptocurrency transactions, including dates, costs, and proceeds, is essential to correctly calculate and claim these deductions.

For example, if you had a net capital loss of $8,000 in one year, you could deduct $3,000 against your ordinary income. The remaining $5,000 would carry over to the next year. If in the subsequent year you have capital gains of $2,000, you would use $2,000 of your carried-forward loss to offset those gains, and then you could deduct another $3,000 against your ordinary income, fully utilizing the $5,000 carryover.

Reporting Crypto Transactions to the IRS

Taxpayers are required to report all sales and exchanges of cryptocurrency to the IRS. This reporting primarily involves two specific tax forms: Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, Capital Gains and Losses.

Form 8949 is used to list each individual cryptocurrency sale or exchange. For each transaction, you must provide details such as the description of the asset, the date it was acquired, the date it was sold, the sales price, and its cost basis. This form categorizes transactions by holding period, distinguishing between short-term and long-term gains or losses.

After completing Form 8949, the totals of your net short-term and long-term capital gains or losses are then transferred to Schedule D (Form 1040). Schedule D consolidates these amounts from all capital asset transactions to calculate your overall capital gain or loss for the tax year. This form also accounts for any capital losses carried forward from previous years.

The final net capital gain or loss calculated on Schedule D is then reported on your main tax return, Form 1040. The IRS has included a question on Form 1040 asking about virtual currency activity to ensure taxpayers are aware of their reporting obligations. Even if you do not receive tax forms like a Form 1099 from a crypto exchange, you are still responsible for accurately reporting all taxable crypto transactions.