With Crypto Winter and the recent bankruptcies of several exchanges, taxpayers want to know the best way to report their losses for tax purposes. There is no simple answer and the appropriate tax return will depend on how the loss occurred. Below, in question and answer format, are some scenarios and possible tax filing positions.
The value of my holdings decreased substantially due to market conditions, but they are still tradable. Can I get a deduction for the decline in value without selling the coins to avoid trading costs? A. No. While for GAAP accounting purposes decreases in market value are charged to the financial statements, for tax purposes there must be a sale. But the good news is that digital assets are currently not subject to the "wash sale" rules that securities are subject to, so if you still want to hold on to the investment, you can buy it back immediately and "reap" a tax loss. .
Does the realized loss include the highest fair market value of the digital asset (“DA”) less the sales price or is it limited to the actual cost of the DA? A. The loss is limited to the actual cost. So, if your cost was $1,000, the DA became worth $10,000 and is now worth only $500, your true deductible loss on sale is $500, not $9,500.
The exchange I trusted to hold my DA is frozen and in the process of liquidation. In the meantime, I don't have access to my DA, but its value has decreased substantially and it is still trading on other exchanges. Can I take a loss from a decrease in my cost base? A. Probably not, as they are still trading on other exchanges and the fact that they are locked on the frozen exchange does not allow you to create a full transaction to take your loss. You may have to wait until settlement is complete and the DA is tradable again to calculate your loss.
I lent my DA to a Defi exchange to stake or lend and now the DA has become worthless and is no longer tradable. Can I take a tax loss on the loan? A. You may be able to get a nonbusiness bad debt deduction for the loan, which is treated as a short-term capital loss. Such loss is deductible from ordinary income up to a limit of $3,000 per year, but is deductible from other capital gains without any limit. Any loss carryover is carried forward forever until it is used. These rules are complex and their specific facts would need to be addressed.
I put my DA on an exchange and they became worthless simply because of market conditions. They no longer trade. Can I take a “worthless” security deduction for the loss? A. DAs are treated as property for tax purposes, not securities. As such, they have to be “sold or exchanged” to trigger the loss, unlike securities where a “worthless” designation would allow the loss.
The exchange I used to keep my DA closed due to a "hack" of their assets. It is in liquidation and I may have to wait several years to recover a fraction of my investment. Can I deduct my loss as a theft/accident loss? A. This is a controversial area. If it is a casualty or theft loss that caused the exchange to close, the Internal Revenue Code does not currently allow such losses under a law that will be in effect until 2025. If the previous law, which allowed losses from theft, is again law as scheduled, and that is when the loss crystallizes, then you should be able to take the loss.
When Madoff's Ponzi scheme was discovered, the IRS issued several Revenue Procedures in 2009 that allowed ordinary losses to be taken at varying percentages depending on certain factors. Why wouldn't current bankruptcies or “gimmicks” qualify for similar treatment? A. Madoff's theft losses were direct losses to investors who had deposited money with him, which he embezzled. Additionally, theft losses were allowed as ordinary deductions at the time. An exchange's current "tricks" where individual DAs are stolen would seem to qualify for outright theft, but theft losses are currently not deductible at all until the current law expires in 2025. Additionally, if general embezzlement or theft of assets on an exchange lead to their demise due to lack of capital but there is no direct link to the theft of an individual's assets, that is not considered a “theft” loss. These rules are complicated and each set of facts must be examined to determine what tax law might apply to allow for any current tax loss.
Please note that these questions and answers focus on