Did your clients have net losses in their cryptocurrency portfolio this tax year? As with any other capital loss, your clients can use crypto losses to offset capital gains or reduce their taxable income. Here’s what you should know to help your clients make the most of crypto losses on their tax return.
How does the IRS treat cryptocurrency?
The IRS views cryptocurrency as property, meaning it’s subject to the same capital gains taxes as stock and other investments. Claiming capital losses on cryptocurrency works similarly. If you already know how to claim capital losses on your clients’ tax returns, helping them claim crypto losses should be simple once you calculate them.
Offsetting Capital Gains
Like any other capital loss, crypto losses can be used to offset any capital gains that were realized in the same tax year. For example, if your client had $10,000 in realized capital gains from their stock investments and $6,000 in losses from their cryptocurrency investments, they can use the crypto losses to reduce their net capital gains to $4,000 – just as they would with any other type of capital loss.
Like other capital assets, cryptocurrency can generate short-term (for assets held less than a year) or long-term (for assets held a year or more) capital gains and losses. Short-term and long-term gains have different tax rates and are reported separately on Schedule D of Form 1040. You must first use short-term losses to offset short-term gains and long-term losses to offset long-term gains. After that, you may use any remaining losses to offset either type of gain.
Reducing Taxable Income & Carryforward Losses
If your client’s crypto losses exceed their capital gains from all investments, they can use the losses to deduct up to $3,000 from their taxable income. If their loss was greater than $3,000, they can carry the loss forward to reduce income or offset capital gains in future years. The same limit applies to carryforward years, so if your client had a total loss of $10,000, they could carry forward $3,000 to reduce taxable income per year for three years and the final $1,000 in the fourth year.
Or, if they have better luck in their investments in the coming years, they could use the carryforward loss to offset their capital gains without limit. In the previous example, they would apply the first $3,000 of their $10,000 loss to reduce their taxable income in the year they incurred the loss.
Let’s say that the following year, they had $8,000 in capital gains. Then they would use the remaining $7,000 in carryforward loss to reduce their net capital gain for the year to $1,000.
Calculating Crypto Losses
On the surface, calculating crypto losses is relatively simple: subtract your client’s cost basis from their proceeds, just as you would to calculate loss or gain on any other capital investment. In practice, keeping track of crypto gains and losses can be a bit trickier. If your clients have traded all their cryptocurrency on the same platform and kept it in the same digital wallet, figuring gains and losses should be straightforward, since most crypto exchanges automatically keep detailed records.
But if your client has moved their cryptocurrency across multiple exchanges and digital wallets, they’ll need to keep their own records, or they might need your help reviewing them. For example, let’s say your client purchased 1 ETH (Ethereum) for $1,000 on CoinBase, then they transferred it to Kraken when it was valued at $600, and then sold it for $700. Their records on Kraken might indicate they have a capital gain of $100 when, in reality, they have a capital loss of $300.
In short, if your clients use multiple exchanges or wallets, you may need to ask extra questions to ensure you have a full picture of their crypto gains and losses. Encourage them to keep detailed records of their activity across different exchanges and wallets and ask where and when they originally bought any cryptocurrency, they sold that year to make sure you have an accurate cost basis.
Reporting Crypto Losses
Need a little more info to feel well-informed on cryptocurrency and other digital assets? Our articles What Tax Preparers Need to Know about Cryptocurrency and What Tax Professionals Should Know About NFTS and Taxes can get you up to speed.