Can You Deduct Crypto Losses on Your Taxes?

The Internal Revenue Service (IRS) classifies cryptocurrency as property for tax purposes, not as currency. This means transactions involving digital assets are subject to capital gains and losses rules, similar to how traditional investments like stocks are treated. Consequently, any losses incurred from cryptocurrency transactions can have significant implications for your tax liability.

How Cryptocurrency is Taxed

The IRS classifies cryptocurrency as property, meaning each time it is sold, exchanged, or otherwise disposed of, a taxable event occurs. This requires calculating a “cost basis,” which is the original value or purchase price of the cryptocurrency, including any associated fees. A “realized gain or loss” is then determined by comparing this cost basis to the fair market value received at the time of disposition.

When cryptocurrency is held for one year or less before being sold, any resulting profit or loss is short-term. Short-term capital gains are generally taxed at an individual’s ordinary income tax rates, which can range from 10% to 37% depending on income levels. If held for more than one year, gains or losses are long-term. Long-term capital gains typically benefit from preferential tax rates of 0%, 15%, or 20%, also dependent on the taxpayer’s income.

Applying Capital Loss Rules

Capital losses from cryptocurrency transactions can be used to offset capital gains, which can lead to a reduction in overall tax obligations. The process of applying these losses involves a specific netting procedure. Short-term capital losses are first used to offset short-term capital gains, and similarly, long-term capital losses are used to offset long-term capital gains.

If, after this initial netting, there are still remaining net losses in either category, they can then be used to offset gains from the other category. For instance, a net short-term capital loss can reduce a net long-term capital gain, and vice versa. Should a taxpayer’s capital losses exceed their capital gains for the year, a net capital loss can be deducted against ordinary income, up to an annual limit of $3,000 for individuals.

Any capital losses exceeding this $3,000 limit in a given tax year can be carried forward indefinitely to future tax years. These carried-over losses can then be used to offset capital gains or up to $3,000 of ordinary income in subsequent years.

The Wash Sale Rule Exception

The wash sale rule is a provision in tax law designed to prevent investors from claiming a tax loss on an investment while maintaining continuous ownership. Generally, this rule disallows a loss if a taxpayer sells a security and then repurchases a “substantially identical” security within a 30-day period before or after the sale. This prevents taxpayers from selling an asset solely to realize a tax loss and then immediately buying it back.

Crucially, the wash sale rule does not currently apply to cryptocurrency transactions. This is because the IRS classifies cryptocurrency as property, not as a security. Consequently, an individual can sell a cryptocurrency at a loss and immediately repurchase the same cryptocurrency without violating the wash sale rule, allowing them to realize the tax loss. This distinction offers a unique advantage for crypto investors, enabling them to engage in “tax-loss harvesting” more flexibly than with traditional securities.

Tax regulations, particularly concerning evolving asset classes like cryptocurrency, can change. Future legislation or updated IRS guidance could potentially extend the wash sale rule to digital assets, altering this significant exception.

Calculating Your Losses and Record Keeping

Accurately calculating cryptocurrency losses requires meticulous attention to detail regarding cost basis and sale proceeds. The cost basis includes the original acquisition price of the cryptocurrency, along with any fees incurred during the purchase. For cryptocurrencies acquired through various methods such as mining, staking rewards, or airdrops, the cost basis is generally the fair market value of the asset in U.S. dollars at the time it was received.

To determine a realized loss, this cost basis is subtracted from the sale proceeds. Sale proceeds encompass the U.S. dollar value received from selling or exchanging the cryptocurrency, minus any transaction fees or commissions paid during the disposition. For example, if a cryptocurrency was acquired for $1,000 (including fees) and later sold for $800 (after fees), the realized loss would be $200.

Maintaining comprehensive records is paramount for substantiating reported losses. Essential documentation includes:
Transaction histories from all exchanges and platforms used
Dates of acquisition and disposition
Amount of cryptocurrency involved
Fair market value at the time of each transaction
Records of all associated fees
Wallet addresses and transfers between wallets to establish a clear audit trail

Utilizing specialized cryptocurrency tax software can simplify this process by aggregating data from various sources and assisting in the calculation of gains and losses, as well as generating necessary tax reports.

Reporting Crypto Losses

Reporting cryptocurrency losses on your tax return primarily involves two specific IRS forms: Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, Capital Gains and Losses. The information gathered from your detailed record-keeping, such as cost basis and sale proceeds, is directly entered onto these forms.

Form 8949 serves as the initial step, where each individual cryptocurrency transaction that resulted in a sale or other disposition is listed. Taxpayers must provide details for each transaction, including:
Description of the property (e.g., ‘Bitcoin’)
Date acquired
Date sold
Sales price
Cost basis

After all relevant transactions are entered on Form 8949, the totals for short-term and long-term gains and losses are then transferred to Schedule D. Schedule D then aggregates these amounts to determine your net capital gain or loss for the tax year, which ultimately flows to your Form 1040.