The IRS warns users against claiming losses from collapsing tokens

What happened

Many cryptocurrencies including luna and its associated terraUSD stablecoin fell from all-time highs to near zero values ​​last year. Dozens have fallen more than 90%. As the April 15 filing deadline approaches, some U.S. taxpayers are wondering whether they can claim these catastrophic losses on their 2022 returns without selling or disposing of the assets.

The recently issued IRS Chief Council Memorandum 202302011 discusses this situation and makes clear that this step can only be taken in very limited circumstances.

Key concepts

The IRS memorandum describes the following scenario and discusses the applicability of the worthless security and loss deductions.

Taxpayer A is an individual investor who bought units of cryptocurrency B in 2022 at

$1 each. After taxpayer A purchased cryptocurrency B, the value per unit of cryptocurrency B decreased significantly (for example, plunged to 99 cents), so that each unit of cryptocurrency B was valued at less than one cent by the end of 2022. On December 31, the token became traded on at least one cryptocurrency exchange. Taxpayer A had what is considered dominion and control over the assets – simply put, the ability to sell, exchange or transfer the coins. In this case, Taxpayer A still has the option to liquidate the asset, which will create a taxable event that can be used to book a capital loss.

Capital loss

ONE capital loss occurs when there is a “sale or exchange” of a capital asset at a loss, according to the US Tax Code (§1222(2) and §1222(4)). To meet the “sale or exchange” criterion, you must dispose of the asset and receive something in return (even if it is an insignificant amount of money or another asset). However, this may not be possible for some cryptoassets because there are no liquid markets to sell them.

Worthless security deduction

As the name suggests, a worthless security deduction applies to securities which no longer have some value. Cryptocurrencies do not qualify under the strict wording below.

According to the tax code, a “security”.

1. A share of stock in a company;

1. A right to subscribe or receive a share in a limited company; or
2. A bond, debenture, note or certificate, or other evidence of indebtedness, issued by a corporation or by a governmental or political subdivision, with interest coupons or in registered form.

The security must also be totally worthless; Partially worthless securities are not entitled to a deduction under this provision.

Taxpayers with coins that have significantly lost value may be tempted to write off the loss under this rule as a capital loss on Form 8949. However, the IRS emphasizes that even if the coin is totally worthless, it is not eligible for the worthless collateral deduction because cryptocurrency does not meet the definition of a “security” under the above definition. It is important to note that the SEC and the IRS do not necessarily use the same definition or have the same opinion about what assets constitute securities.

Loss of abandonment

Taking a loss is even more complicated. According to the tax law, the definition is “a loss incurred in a business or in a transaction entered into for profit and arising from the sudden cessation of the usefulness in such business or transaction of any non-depreciable property, in a case where such business or transaction is wound up or where such property is permanently disposed of from use there, shall be allowed as a deduction in accordance with § 165(a) for the tax year in which the loss is actually incurred.”

Let’s break down the opaque explanation: the definition. Cryptocurrencies are non-depreciable property, which is the good news. But to prove that you had a “transaction entered into for a profit” and permanently discarding the asset can be challenging for crypto transactions.

The IRS memorandum explains that the taxpayer is not eligible to take an interruption loss because he/she took no action to permanently dispose of the asset during the 2022 calendar year; the taxpayer still retained the asset despite it having a value close to zero.

Deduction possibilities

The IRS memorandum does not explicitly recommend ways taxpayers can claim deductions for coins that have lost significant value.

However, the general tax rules still allow you to take a capital loss on the coins as long as you dispose of them properly (provided there is at least one market with liquidity).

For example, say you had a luna position that you paid $1,000 for in 2021. During 2022, this position was worth about $100,000 (Unfortunately, you didn’t take payouts). As of December 2022, the stock was worth just 10 cents. If you find a market with liquidity, you can sell the position for 10 cents and claim a $990.90 capital loss on your taxes. As explained above, you keep the coin in your crypto wallet thinking it is “worthless”. is not enough to claim a tax loss.

It can be rare situations where you may not have access to a liquid market to dispose of your coins and claim a capital loss. In such cases, abandoning the asset may still be a path to deduction. In the crypto world, you may be able to leave an asset by sending it to a burner/null address, as mentioned above, and keep detailed documentation to support the deduction.

For example, say you have Coin X in your wallet. You paid $1,000 to get it, but now the position is worth just a tiny fraction of a cent. You cannot find any exchanges or other third parties at all to throw the coin. Here, a possible alternative would be to send the asset to a burner address to discard it permanently.

However, be aware that you must be careful when taking infrequently used write-offs such as abandonment losses. If you don’t handle them properly, you will increase your chances of being audited. Even when done correctly, the IRS may still question your strategy because the tax return differs from most filings without special deductions. Consult a tax advisor to evaluate the pros and cons of taking sophisticated deductions such as loss on abandonment.

Next step

• Accept that you cannot take a tax deduction just because you consider a crypto position to be worthless.
• Consider disposing of the coins and tokens that have lost significant value in order to claim capital losses in the following tax year.
• Default to non-controversial and more straightforward capital losses when you can.

Further reading