I thought it would be helpful to write this up for everyone. DISCLAIMER - You should still speak with a tax advisor and not treat this as straight tax advice, just information. I am interested in the regulatory side of crypto, so I thought it would be helpful.
Bitcoin and crypto losses can be used to offset other types of capital gains for tax purposes. This guide will discuss how to handle your losses and the important things that you need to keep in mind for your crypto taxes.
Losses on Crypto and Bitcoin trades offset other capital gains
For tax purposes in the U.S., selling crypto is treated the same as selling any other type of capital asset—stocks, bonds, property etc. This means that you realize a capital gains or capital losses anytime you sell Bitcoin or any other cryptocurrency. When you realize a capital gain (you sold your crypto for more than you purchased it for), you owe a tax on the dollar amount of the gain. However, when you sell (or trade) your crypto for less than you purchased it for, you incur a capital loss, and you can use this loss to offset gains from other trades or even a gain from the sale of other property like stocks in your portfolio.
Unfortunately in the crypto landscape that we are currently experiencing, there are plenty of losses to go around, and it is wise to file these capital losses in order to reduce your taxable income and save you money.
Net capital losses up to $3,000 can be deducted against other types of income
Whenever your total capital gains and losses for the year add up to a negative number, you incur a net capital loss. If the net capital loss is less than or equal to $3,000 ($1,500 if you are married and filing a separate tax return), then that entire capital loss can be used to offset other types of income—like the income from your job.
If your losses exceed $3,000, then the amount over $3,000 will be rolled forward to the next tax year.
It's very important to note that before being used to offset other types of income, capital losses offset other types of capital gains. This can provide HUGE tax benefits for people who have capital gains in other areas.
What does this look like in real life?
Let’s go through an example to paint a clear picture.
Let's say you gained $20,000 in the stock market this year (this is a capital gain), and you lost $20,000 trading cryptocurrency. Your loss in crypto would completely offset your 20K stock market gain. Therefore, you would pay no taxes on your stock market activity. If you are at a 25% tax bracket, this form of tax loss harvesting would save you $5,000 in taxes (20,000 * 0.25).
*Note, there are many other forms of capital gains that your crypto can offset.
Tax loss harvesting is a common strategy used by investors of all asset classes: crypto, stocks, bonds, real-estate etc. We break down a step-by-step approach detailing how you can harvest your crypto losses for tax savings in our complete blog post here: Cryptocurrency Tax Loss Harvesting.
What if I have no other forms of capital gains?
In the scenario where you have no other capital gains, your losses simply offset your income up to $3,000.
As an example, let’s say you started 2019 doing really well as a crypto trader. You made $5,000 trading Bitcoin and Ethereum. Once August rolled around and the markets took a turn for the worse, you got hit hard and the value of your portfolio dropped significantly. You ended up selling out of all of your positions and took a $7,000 loss. From here, you would be able to harvest a $2,000 loss for the year. This loss would deduct from your taxable income for the year. Let’s say you made $50,000 on the year in income. With this loss, only $48,000 of that income would be taxable.
Wash sale rules do not apply to crypto
This is very important for those who want to take advantage of their crypto losses. Like mentioned, a taxable event only occurs when you sell or trade your crypto into another crypto. This means that if you want to take advantage of your losses from 2018, you should sell or trade out of your crypto before Dec. 31st, 2018. By trading into another cryptocurrency, you trigger a taxable event and "realize" your losses on paper. You can then file these losses with your tax return. Please consult with a qualified tax professional regarding these tactics.
Because wash sale rules do not currently apply to cryptocurrency, you can buy back the crypto you sold to "harvest" your losses. This immediate buyback is not allowed in the world of stock trading. This is very helpful for those who want to continue to hold onto their crypto, and this form of tax loss harvesting is a common tactic amongst tax professionals.
An example - If you bought $2,000 worth of Bitcoin in February of 2018, that investment would now be worth about $600 USD give or take. To take advantage of this loss, you should trade all of that Bitcoin for Ethereum BEFORE Dec 31st and then trade back that same amount. Now you still have your Bitcoin, but you also "realized" this $1,400 loss on paper. This loss offsets other gains or income on your tax bill!
You can trigger a loss on paper by trading into another cryptocurrency, or by selling into FIAT currency. Both are taxable events and allow you to "realize" your loss.
IRS Form 8949
To get more detailed on how to report this crypto on your taxes, you need to report each trade that you made on the IRS form 8949, Sales and Dispositions of other Capital Assets. For every trade that you made during the year, you list the amount of crypto traded, the price traded at, the date traded, the cost basis for the trade, and the capital gain or loss that occurred. Continue to list every trade from the year on this form and total up the net losses at the bottom.
What if I made a lot of trades during the year?
A lot of crypto enthusiasts trade quite often. If you haven’t been keeping a record of the dates of your trades, the dollar value amounts that you bought and sold your crypto for, and the capital gains/losses from those trades, this reporting process, and creating your 8949 form can become a huge headache. If this is a scenario that you are faced with (don’t worry we were in the exact same boat), it could be beneficial to leverage cryptocurrency tax software like CryptoTrader.Tax to automatically create your 8949 for you. All you have to do is import your trades.
Once you have your total capital gains and losses added together on the form 8949, you transfer the total amount onto your 1040 Schedule D.
Wrapping Up
Ideally you are a wizard of a crypto trader, and you won’t have to harvest any losses from your trading activity. However, if you have losses, be sure you are at least taking advantage of them and saving money where you can.
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