Can You Write Off Crypto Losses With Crypto Tax Deducts?

Did you lose money on cryptocurrencies this year and wondering if can you write off crypto losses. The good news is that you could reduce your taxes by thousands of dollars.  Many cryptocurrency investors have lost money, either as a result of platform failures or underperforming investments. 

The bright side is that crypto losses can sometimes be advantageous regarding taxes as they can lower your taxable income and offset profits.

This comprehensive guide addresses various types of cryptocurrency losses, their reasons, pertinent tax laws both domestically and abroad, tactics including tax-loss harvesting, and resources that might help with this process.

Understanding the Types of Crypto Capital Losses

For cryptocurrency investments, when a digital asset (Solana, Bitcoin, Ethereum, or any other altcoins) is sold for less than its acquisition price, the loss is usually classified as a capital loss; these disposals include trading, spending, and selling any kind of crypto asset.

For example, if you bought $100,000 worth of Ethereum and sold it for $90,000, your capital loss is $10,000. Capital losses can be classified as either short-term or long-term. When you sell cryptocurrency you have owned for less than a year, you incur a short-term capital loss; when you sell cryptocurrency you have owned for more than a year, you incur a long-term capital loss.

Can You Write Off Crypto Losses?

Although no one loves a bad investment, investors can use these realized losses to offset a certain range of capital losses against their capital gains, which is advantageous from a tax viewpoint.

Additionally, you can deduct an extra $3,000 from your regular income year if your losses outweigh your earnings.  You can carry over whatever losses you may still have to offset profits in subsequent years.

In situations like losing your cryptocurrency assets in an exchange bankruptcy or if its value has dropped to zero, you could be eligible to recover losses.  The tax breakdown of these situations will be discussed later in this article, but first, let’s find out what might be the cause of these substantial losses in the crypto market.

The Various Types of Losses Incurred in the Cryptocurrency Market

Can you write off crypto losses? Well, the answer is yes! However, what might be the cause of these losses, and how do they affect a trader's portfolio? There’s no doubt that the risks associated with the cryptocurrency market could result in significant financial losses, and investors hoping to negotiate this unstable environment successfully must be aware of these hazards. 

Hence, below is a list of the various types of losses in the crypto market:

Regulatory Uncertainties

The regulatory landscape in which cryptocurrencies operate is totally different and unique from any other sector. Abrupt changes in laws or government regulations may negatively impact the value of digital assets. 

Market downturns and investor losses may result from strict rules, outright prohibitions in particular regions, or announcements from regulatory bodies. A clear example was the executive order by President Donald J. Trump, who gave a go-ahead on a crypto-strategic reserve that included SOL, ADA, BTC, and ETH.

Fraudulent schemes and scams

Numerous frauds and rug pulls, including phishing attacks, Ponzi schemes, and fraudulent ICOs, have plagued the cryptocurrency industry. Scammers often trick investors into the market's unregulated structure by creating scam projects and memecoins, which are then liquidated in seconds, causing large financial losses.

Market Volatility

Crypto market volatility is a well-known characteristic that causes massive losses of funds and portfolio wreckage for both new entrants and crypto whales. Rapid and erratic price movements are caused by a number of factors, including leverage, speculative trading, and insufficient liquidity.

For example, panic selling can amplify the downward pressure on prices by setting off liquidations and stop-loss orders. These price fluctuations are further worsened by outside factors such as macroeconomic changes, security lapses, or regulatory crackdowns.

Security Vulnerabilities

Due to the decentralized and digital nature of the crypto market, hackers frequently target individual wallets and exchanges to steal money and digital assets worth millions of dollars. 

Even with improvements in security measures, the possibility of hacking is still a major worry for cryptocurrency investors, traders, and exchanges. A vivid example was the recent hack of ByBit which led to the loss of funds. However, they were later recovered, underscoring how security vulnerabilities could be a major problem.

Fear-of-Missing-Out (FOMO)

More often than not, major mishaps in financial investments are significantly influenced by investor psychology, as poor investing decisions can result from emotions, greed, and panic selling during market drops.

For a crypto trader to make significant profits and cut down on losses, it is essential to manage and control these emotional reactions, thereby further preventing detrimental actions in the cryptocurrency market.

Bugs and Technical Failures

Capital loss may result from technical problems with smart contracts or blockchain networks. For example, hackers may take advantage of flaws in smart contract programming to cause financial losses. Sadly, compared to conventional financial systems, there are frequently few possibilities for correction in these situations. ​

Leverage and Margin Trading

Leverage and margin trading increases the possibility for gains and losses; however, leveraged positions can be quickly liquidated in an extremely volatile cryptocurrency market, especially if the market swings negatively, resulting in losses that might surpass the initial investment.

Tax Rules for Crypto Losses

Cryptocurrency losses may have significant tax implications; we'll go over how to report them correctly, what paperwork you'll need, and how to maximize your deductions. 

U.S Tax Rules

How to Report Crypto Losses to the IRS

You must file IRS Form 8949 (Sales and Other Dispositions of Capital Assets) and Schedule D (Capital Gains and Losses) to record your crypto capital losses.  This procedure includes listing the purchase and sale dates, the sums involved, and the profit or loss.

The IRS mandates that you register all cryptocurrency sales because it views cryptocurrency as property. If applicable, losses from cryptocurrency can deduct up to $3,000 from your income or offset capital gains, including future capital gains.

Offsetting Gains 

Regardless of how well your assets' combined performance has been, crypto losses can offset other capital gains from the current or future tax year (if carried forward). Likewise, up to $3,000 of the excess loss can be written off against regular income each year if overall capital losses exceed total capital profits. Any remaining losses can be carried forward indefinitely to subsequent tax years.

Capital gains: As previously mentioned, losses incurred by cryptocurrency may be used to offset an unlimited number of gains.

Whether your profits are long-term (taxed between 0-20%) or short-term (taxed between 10-37 %), it will affect the tax rate you pay. You can only be able to avoid a significant tax payment if you have a sizable amount of capital gains.

Income: Your income is subject to 10–37% taxation, depending on your tax rate. For traders writing off a whole $3,000  income for the year, your tax savings will vary from $300 for those in the lowest bracket to $1,110 for those in the highest bracket. 

How to Report Crypto Losses on Taxes

Before the 2017 Tax Cuts and Jobs Act (TCJA), taxpayers who satisfied three requirements may often claim theft losses:

• Evidence of theft in accordance with the law.
• The amount of deductible loss was restricted to the taxpayer's ownership stake in the extorted asset.
• As long as there was no realistic chance of recovery, the loss could only be reclaimed in the year the theft was detected.

TCJA essentially prohibited personal theft losses unless they were associated with a disaster region proclaimed by the federal government.  Moving on, this caused uncertainty for victims of fraud, particularly those impacted by cryptocurrency and internet fraud.

Following the revised directive from memorandum CCM 202511015, the IRS has provided clarification on whether certain losses qualify for a theft loss deduction following TCJA: Below are such fraud scenarios:

1. Compromised Account: For cases where a scammer deceives someone and gets access to a trading account, the IRS decided that such a person can file a theft loss claim under section 165(c)(2). This is because he/she had a motive to invest and profit with such an account. Nonetheless, he/she must still recognize income from the IRA distribution. The tax impact can be mitigated by the revenue realized, which raises the basis of the theft loss.
2. Phishing Scam: When a person gets a phishing email from someone posing as a financial institution, which leads to getting access to their login credentials and moving money from both IRA and non-IRA accounts. According to the IRS, the theft of assets stored in investment accounts meant for profit fulfilled the profit motivation criteria, allowing the claimant to claim a theft loss under section 165(c)(2).
3. Losses From Casualties: Casualty losses happen when an abrupt, unforeseen, or unusual incident causes your property to be damaged, destroyed, or lost. This might involve inadvertently transferring money to the incorrect address or losing your private keys in cryptocurrency. Although losses in a profit-oriented transaction are deductible, it is sometimes challenging to prove that these losses satisfy the requirements.
   
   Consequently, the majority of casualty losses associated with cryptocurrency are not deductible. For some who believe their casualties should be deducted, such can be reported on Form 4684, Section B, Part II. However, you will be disqualified to claim this deduction if you anticipate receiving some of the lost money back by insurance or another method. 
   
   In addition, you must itemize your tax return or ensure your deductible loss is more than your standard deduction level to qualify, or you won't get any further tax benefits if your loss falls below these limits.
4. Losses from Theft: Theft is the illegal seizure of property with the intention of depriving the owner. According to the TCJA, only theft losses associated with profit-oriented transactions are deductible for tax purposes between January 1, 2018, and December 31, 2025.
   
   To report losses from theft, fill out Form 4684, Section B, Part II, if you have a deductible theft loss. Generally, you may write off the loss in the year it was found unless you think you'll get the money back. In that instance, you have to wait until it's obvious that recovery isn't feasible. This deduction is only available if you itemize your taxes or your loss exceeds the standard deduction level.

International Perspective

India

According to Indian tax laws, losses from one cryptocurrency cannot be used to offset gains from another or other income sources. Hence, tax implications are applied differently to each cryptocurrency investment.

The United Kingdom

Cryptocurrencies are subject to general UK Capital Gains Tax (CGT) regulations. Gains from other assets might be used to offset losses for investors. However, for losses to be recorded, they must be reported to Her Majesty's Revenue and Customs (HMRC).

Tax Loss Harvesting Strategies

Tax loss harvesting is the process of recovering capital losses by selling underperforming assets.  These losses decrease your overall tax burden, which either balances taxable gains or lowers regular income.

For instance, if you sell Solana for a $13,000 loss but make $15,000 in gains from Cardano, you will only be required to pay taxes on the $2,000 in earnings.

What is the Process of Crypto Tax Loss Harvesting?

 Harvesting cryptocurrency taxes entails you:

• Recover capital losses by selling cryptocurrency assets at a loss.
• Utilize losses to balance off other assets' capital gains.
• Deduct excess losses from regular income up to $3,000 annually (US).
• Excess losses can be carried over to subsequent years by US taxpayers.

What are the Advantages of Crypto Tax Loss Harvesting?

• Reduce taxes by lowering taxable income and offsetting gains.
• It serves as long-term savings, which defer excess losses to subsequent tax years.
• It efficiently manages investors' portfolios, optimizing taxes while rebalancing your holdings.

What are the Disadvantages of Crypto Tax Loss Harvesting?

• Loss of Future profits: Selling might result in the loss of possible price recovery.
• Lower cost basis: Future profits may increase when realized losses lower the cost basis.
• Regulatory risk: Wash sale regulations for cryptocurrencies may be imposed by future IRS modifications.

How to Strategically Sell Assets at a Loss to Reduce Tax Liabilities

To successfully apply tax loss harvesting:

1. Detect losses: Pay attention to your portfolio's failing investments.
2. Strategic selling: Give short-term losses priority as they counteract higher-taxed short-term profits.
3. Strategic reinvestments: To reduce future IRS concerns, plan for reinvestments by not buying the same asset again within 30 days.

 Timing of Crypto Tax Loss Harvesting

 There are two primary ways to profit from cryptocurrency losses:

• To apply losses to the current tax year, they must be harvested before December 31.
• Utilize price reductions to optimize loss harvesting during market downturns.

Challenges of Crypto Tax Loss Harvesting

Harvesting cryptocurrency tax losses has its share of challenges; below is a brief summary of what to watch out for.

• Market volatility, as the price of cryptocurrencies tends to vary a lot.
• Calculations and tracking are more difficult due to varying holding durations and purchase prices (cost basis).
• Techniques like wash sales may be impacted by upcoming IRS regulation decisions.

When in doubt, seek additional advice from a crypto tax expert.

How Should I Manage Short-term versus Long-term Gains When Harvesting Tax Loss?

Since short-term profits are subject to higher ordinary income tax rates, it is best to prioritize harvesting losses from short-term holdings first, as tax rates are more beneficial for long-term gains.

Rules Regarding Wash Sales in the US and Potential Future Changes

The wash sale rule restricts investors from recovering losses on sold and bought-back assets.  Learning about these regulations is crucial for cryptocurrency traders to plan trades and file taxes properly. 

When an investor sells a cryptocurrency or investment at a loss and then promptly buys the same or a nearly similar asset again in an effort to claim a capital loss, this is known as a "wash sale." The wash sale rule is closely connected to tax-loss harvesting.  By achieving a capital loss that can offset capital gains or lower regular income by up to $3,000 per year, investors can use this method to lower their tax obligations by selling investments with unrealized losses.

In addition, repurchasing cryptocurrency assets for US users right after selling them leads to a crypto wash sale, disqualifying the loss for tax reasons if the investor retains ownership of the item. Investors should wait at least 30 days before buying back an asset they have sold to prevent this. However, there is a risk associated with this waiting time because the asset's price may fluctuate, affecting the anticipated tax advantages.

Even while the IRS hasn't said outright that the wash sale rule applies to cryptocurrencies, growing regulatory oversight and legislative efforts point to a shift toward more stringent tax laws that might plug current gaps in the tax treatment of cryptocurrencies.

How Does the Rule About Crypto Wash Sales Work?

According to 26 U.S. Code Section 1091, loss from wash sales of stock or securities, securities (such as stocks and bonds) are governed by this law. This implies that if you own an investment that has lost value, you are not allowed to sell it to recover losses and then purchase it again within 30 days.

This law prohibits taxpayers from balancing their profits and reducing their capital gains tax burden, thereby stopping them from creating fictitious losses. The rule's primary objective is that if an investor buys back a nearly similar security or cryptocurrency asset within 30 days after selling it, they cannot claim capital losses for tax reasons.

How Can I Save Taxes With the Crypto Wash Sale Rule?

Since cryptocurrencies are regarded as property rather than securities, they are now exempt from the IRS wash sale regulation. This essentially implies that no law forbids the selling of cryptocurrency washes.

This also means that sales of cryptocurrency washes are legally permitted. However, regulators and authority bodies have hinted that this might change soon. 

Tools and Resources That Can Help You With Reducing Your Tax To Write Off Your Crypto Loss

Several platforms offer tools to calculate and report cryptocurrency gains and losses:

Use of Tax Calculators

TokenTax: TokenTax simplifies the process of reporting cryptocurrency losses on your tax return.  In addition to real-time tax reports that help customers see their tax due in advance and be ready for their filings, they provide an easy-to-use data import function that enables users to connect all their wallets and accounts without manual data entry.

Additionally, TokenTax customers can access customized reports for Ethereum gas fees, mining and staking income, and tax loss harvesting.  All required tax forms, such as Form 8949, FBAR, and foreign forms, are automatically generated by TokenTax, simplifying the filing procedure.

TokenTax provides sophisticated reconciliation services from tax experts with expertise in cryptocurrency for investors with more complicated accounting requirements.

Koinly: With Koinly, you can tag any lost or stolen cryptocurrency. All you have to do is use the appropriate tags to locate the correct transaction.

In addition, Koinly does not record any profits from these trades but does not record any losses. You must file a claim with the appropriate tax body to achieve this. Using records of your transactions, profits, and losses, our cryptocurrency tax calculator may assist you in gathering proof to support this claim.

CoinLedger: CoinLedger creates a comprehensive tax report that includes your income, profits, and losses. Your tax report can then be sent to your tax expert or exported to websites such as TurboTax and H&R Block.

Along with your reports, CoinLedger provides a comprehensive tax-loss harvesting tool to assist you in determining which cryptocurrencies in your portfolio have the most potential for tax savings and the greatest unrealized losses.

Professional Advice

As a taxpayer, it is your obligation to adhere to tax laws. Whether or not you have obtained the necessary documents from exchanges, all taxpayers must record their cryptocurrency activity to the IRS on their taxes.

Coinbase and other cryptocurrency exchanges disclose information to the IRS without providing customers with tax forms, and investors in cryptocurrency have gotten letters from the IRS advising them to report their cryptocurrency taxes and/or pay additional taxes.

Hence, to safeguard their financial interests and maintain compliance, investors can benefit greatly from seeking advice from cryptocurrency tax experts like TokenTax, CoinLedger, and Koinly, who can guide them through the constantly changing legal environment and help them make wise decisions.

Conclusion

A full understanding of the impacts of taxes and careful preparation are necessary for handling digital currency losses effectively. Investors can manage the complexity of crypto taxes and perhaps reduce financial losses by being conversant with pertinent tax rules, putting methods like tax-loss harvesting into practice, and using the available tools and expert guidance. Before proceeding with these write-offs, it is advisable to speak with a tax professional to assess the pros and cons, as the expenses of an audit may exceed the possible tax savings.

Frequently Asked Questions

Can you write off crypto losses that are Stolen?

Unfortunately, there is no way to retrieve stolen cryptocurrency if you no longer possess it. The IRS confirmed in 2018 that stolen cryptocurrency cannot be written off, as the only losses that could be written off under Form 4686 (Casualties and Thefts) must result from a declared catastrophe.

What Happens If My Cryptocurrency Losses Go Unreported?

The IRS mandates that all cryptocurrency transactions, including losses from sales, be reported by US taxpayers. In addition, crypto losses cannot be used to offset income or capital gains, and unreported cases can result in fines and increased IRS scrutiny.

Is it lawful to harvest tax losses?

Yes, harvesting tax losses is a legal strategy to reduce taxation.

Does Tax-loss Harvesting Have a Limit?

Yes, in the United States, excess losses can be carried forward to offset up to $3,000 of regular income every year.