Editor’s Note: This is an updated version of an article first published on August 17, 2022.
Even before crypto exchange FTX imploded this week, shaking the foundations of the digital asset world, crypto investors had had a volatile, loss-making year. They saw the price of their digital assets plunge, then recover somewhat, then fall again.
Bitcoin, for example, is now down about 65% so far this year, and more than 75% off its all-time high.
If you bought a cryptocurrency on the rise and sold your holdings this year—or are considering doing so—there are at least a couple of ways you might be able to lessen the sting of the loss.
You can use a capital loss in crypto to offset any capital gain you have realized this year – even if it comes from the sale of another security or property, such as a share or a house.
For example, say you bought bitcoin for $50,000 in February 2021, and then sold it in mid-August of this year for $24,000, you would have a long-term capital loss of $26,000, because you held the investment for more than a year.
Say you also booked a $10,000 capital gain by selling a long stock in a taxable brokerage account (ie, not a tax-deferred account like a 401(k) or IRA).
You can fully offset the tax owed on your $10,000 capital gain against $10,000 of your capital losses on your 2022 tax return. In addition, you can also use your losses to offset the tax you owe on up to $3,000 of your ordinary income this year.
Any losses that you don’t use up this year can still be used in future years. So in the example above, you would use half of your capital losses this year ($13,000) to offset $10,000 in capital gains and $3,000 in income. You can then carry forward the other half of your losses to future years. And if you have a year where you have no gains to offset, you can still use $3,000 of your losses to offset taxes on $3,000 of your income.
But when you die, your losses will die with you for tax purposes. You cannot bequeath them to someone else to use. “Your heirs don’t inherit the losses,” said Larry Pon, a California-based CPA and certified financial planner.
Unlike with stocks, you can choose to sell a losing crypto asset to claim the tax loss, but then buy the same asset again around the time of the sale.
Here’s why: For tax purposes, crypto assets are classified as property, not securities. So while you can use capital losses from both types of assets to offset one’s gains, there is a different tax rule that only governs securities and does not apply to crypto assets. At least not yet.
It’s called the wash-sale rule. The IRS will disallow any capital loss you claim on the sale of a stock or security if you buy it back or something “substantially identical” within 30 days before or after the sale.
There is no comparable rule for crypto. “While the IRS has not specifically addressed the area, most practitioners are of the view that the wash sale rules generally do not apply to crypto. The IRS has stated that they treat virtual currency as property, while the wash sale rules apply to stocks and securities,” said Mark Luscombe, senior federal tax analyst for Wolters Kluwer Tax & Accounting.
So, if you book a loss but still believe that the same crypto-asset holds its promise in the long term, you can buy it back at any time. Even on the same day you sell.
“If you sell [a cryptocurrency] and quickly buy it back, which will enable you to tax loss harvesting without triggering the 30-day rule,” said Kell Canty, CEO of crypto-tax software provider Ledgible.
This trading advantage over securities may not last forever. Lawmakers have already proposed expanding the wash sale rule to cover crypto and other assets in proposed legislation. But the chances of that expansion happening this year are very low.
“This rule may change in the future, but for 2022, crypto assets are not subject to the wash sale rules,” Pon said.
One exception may be if you have indirect exposure to crypto assets, for example through an exchange-traded fund that trades on an exchange, such as the ProShares Bitcoin ETF (BITO).
“Trading on an exchange may allow the IRS to treat such crypto as a security and [therefore] subject to wash sale rules,” Luscombe said.
