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Friday, Jul 26, 2024

Lose big on crypto? Here's how to reduce the sting

Lose big on crypto? Here's how to reduce the sting

It's been a tough year for crypto investors as they've watched the price of their digital assets plummet.

Bitcoin, for example, is trading about 65% off its all-time high, which it hit only nine months ago.

If you bought a cryptocurrency when it was on the rise and sold your holding this year -- or are considering doing so -- there are at least a couple of ways you may be able to reduce the sting of your loss.

Using a loss to your advantage


You can use a capital loss in crypto to offset any capital gain you've realized this year -- even if it comes from the sale of another security or another property, such as a stock or a house.

For example, say you bought bitcoin at $50,000 in February 2021, then sold it recently at $24,000, which is roughly where it is trading today. You'd have a long-term capital loss of $26,000, because you held the investment for at least a year.

Then say you also booked a $10,000 capital gain by selling a long-held stock in a taxable brokerage account (i.e., not a tax-deferred account like a 401(k) or IRA).

You can fully offset the tax owed on your $10,000 capital gain with $10,000 of your capital losses on your 2022 tax return. In addition, you also can use your losses to offset the tax owed on up to $3,000 of your ordinary income this year.

Whatever losses that you don't use up this year, you can still use in future years. So in the example above, you would use half your capital losses this year ($13,000) to offset your $10,000 capital gain and $3,000 in income. Then you can carry forward the other half of your losses into future years. And if you have a year where you don't have any 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 can't bequeath them for someone else to use. "Your heirs don't inherit the losses," said Larry Pon, a California-based certified public accountant and certified financial planner.

Wash-sale rules don't apply to crypto ... yet


Unlike with stocks, you can choose to sell a losing crypto asset to claim the tax loss but then buy the very 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 another tax rule that governs only 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 repurchase it or something "substantially identical" to it within 30 days before or after the sale.

There is no comparable rule for crypto. "Although 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, principal federal tax analyst for Wolters Kluwer Tax & Accounting.

So if you book a loss but still believe that the same crypto asset holds promise long-term, you may repurchase it at any time. Even on the very same day you sell.

"If you sell [a cryptocurrency] and rapidly buy it back, that will enable you to tax loss harvest without triggering the 30 days 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 be changing 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, such as through an exchange-traded fund that trades on a stock exchange, such as the ProShares Bitcoin ETF (BITO).

"Trading on a stock exchange could permit the IRS to treat such crypto as a security and [therefore] subject to the wash-sale rules," Luscombe said.

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