What Happens If You Lose Money in Crypto?

Understanding the tax implications of digital assets is essential, especially when investments do not perform as expected. For federal tax purposes, the Internal Revenue Service (IRS) treats cryptocurrency as property, not as currency. This classification means that transactions involving digital assets are subject to the same general tax rules that apply to other property transactions, such as the sale of stocks or real estate. Losing money in cryptocurrency investments carries specific tax consequences that taxpayers need to comprehend for accurate reporting.

Understanding Crypto Losses for Tax Purposes

The IRS classifies cryptocurrency as property. When you dispose of it, any resulting loss is treated as a capital loss, aligning digital assets with traditional investments like stocks or bonds for tax purposes. It is important to distinguish between a loss that exists on paper and one that has been finalized.

An unrealized loss occurs when a cryptocurrency’s market value drops below its purchase price, but the asset has not been sold. This is a paper loss and does not trigger tax implications. Taxes apply only to realized losses, which occur when you sell, trade, or dispose of your cryptocurrency for less than you paid.

Capital losses are categorized as either short-term or long-term, depending on the holding period. If you held the cryptocurrency for one year or less, the loss is short-term. If held for more than one year, the loss is long-term.

Calculating a loss requires knowing the cost basis and the proceeds received. The cost basis is the original purchase price, including transaction fees. Proceeds are the amount received from selling, trading, or using your cryptocurrency. The difference between these figures determines your capital gain or loss.

Calculating and Reporting Your Crypto Losses

Once a cryptocurrency loss is realized, it becomes eligible for tax reporting. Calculate the specific loss for each transaction by subtracting the cost basis from the proceeds received. For example, if you bought crypto for $5,000 and sold it for $3,000, your loss is $2,000.

Report individual transactions on IRS Form 8949, “Sales and Other Dispositions of Capital Assets.” This form requires details like asset description, acquisition and sale dates, proceeds, and original cost basis. Form 8949 is divided into sections for short-term and long-term transactions.

After completing Form 8949, transfer the totals to Schedule D (Form 1040), “Capital Gains and Losses.” Schedule D consolidates all capital gains and losses, including cryptocurrency, to determine your net capital gain or loss for the tax year. This form calculates the overall impact on your taxable income.

If your total capital losses exceed your total capital gains, you can deduct a limited amount against your ordinary income. For individuals, this annual limit is $3,000, or $1,500 if married filing separately. Any capital losses exceeding this limit can be carried forward indefinitely to future tax years.

Maintaining accurate records of all cryptocurrency transactions is essential for proper tax reporting. This includes transaction dates, amounts, and fees for both acquisitions and dispositions. Comprehensive records simplify calculating cost basis and proceeds, supporting information reported on Form 8949 and Schedule D.

Special Considerations for Crypto Losses

A unique aspect of cryptocurrency taxation is the current non-applicability of the wash sale rule. This rule prevents investors from claiming a loss on a security if they repurchase a “substantially identical” security within 30 days. It aims to prevent artificially generating losses while maintaining an investment position.

The wash sale rule does not apply to cryptocurrency because the IRS treats digital assets as property, not stocks or securities. This means a taxpayer can sell crypto at a loss and immediately repurchase it, still claiming the realized loss. Legislative changes could extend this rule to cryptocurrencies in the future.

Losses from cryptocurrency theft or scams are treated differently than capital losses from trading. Under current tax law, personal casualty and theft losses are not deductible for tax years 2018 through 2025, unless they occur in a federally declared disaster area. Therefore, if your cryptocurrency is stolen or lost due to a scam outside a federally declared disaster, you cannot deduct that loss.

While a loss from fraud or a scam might be argued as an investment theft loss in profit-motivated transactions, the criteria are specific and difficult to meet. Personal theft losses, including cryptocurrency, are not deductible under current law unless part of a federally declared disaster.

Seeking professional assistance can be beneficial due to the complexities of cryptocurrency tax law. For significant losses or unique loss events, consulting a qualified tax professional is advisable. A tax professional can provide tailored guidance, ensuring compliance with IRS regulations.