Investors who recently sold their bitcoin positions at a loss should be alert to four special rules that determine how to treat cryptocurrency losses for tax purposes.
Rule #1. Losses on cryptocurrency offset other types of capital gains.
For tax purposes, selling bitcoin and other types of cryptocurrency is treated as selling a capital asset. That means a loss on cryptocurrency is very similar to a loss incurred when selling a stock or bond.The gain or loss is measured on each transaction where the cryptocurrency is sold.
Losses on one particular trade directly offset gains on other trades, whether the gain from another coin or even gain from your stock portfolio.
This can be a useful tax planning strategy. Losses accumulated throughout the year provides an opportunity to sell other investments with unrealized gains — a tax strategy known as capital loss harvesting.
Rule #2. Net capital loss up to $3,000 can be deducted against other types of income.
Whenever a person’s total capital gains and losses for the year add up to a negative number, a special rule comes into play. This is referred to as a net capital loss.
If the net capital loss is less than or equal to $3,000 (or $1,500 if you are married and filing a separate tax return), then the entire amount of the net capital loss can be used in that year’s tax return to offset other types of income. Offsetting other types of income simply means that the net capital loss reduces how much income is being taxed this year.
Rule #3. Any net capital loss in excess of $3,000 will roll over to next year.
If the net capital loss is more than $3,000 (or $1,500 if you are married and filing a separate tax return), then only $3,000 (or $1,500) of losses can be taken in the current tax year, and the remainder of the capital loss carries over to next year’s tax return.
For example, if you have $10,000 of net capital losses and you are a single taxpayer, then you deduct $3,000 of your capital losses against your other income (which produces a tax benefit this year). The remaining $7,000 of net capital losses roll over to next year’s tax return (which produces a tax benefit on next year’s tax return).
Rule #4. The wash sale rule does not apply to cryptocurrency.
The wash sale rule kicks in if an investor repurchases the same or a substantially identical investment within 30 days before or 30 days after selling the original investment at a loss. The intent of the wash sale rule is to prevent an investor from selling an investment at a loss solely for tax purposes, only to repurchase the same investment immediately or in a short window of time.
A crucial question is whether the wash sale rule applies to investments in bitcoin and other cryptocurrencies?
Good news, because the short answer is no. The wash sale rule does not apply to digital currencies. That’s because the wash sale rule only applies to sales of stock and securities. And bitcoin is not a stock or a security. From a tax perspective, digital currency is treated as property.
Suppose a trader sold three bitcoins on February 5, 2018, at a loss. On February 12, 2018, the trader bought three new bitcoins. Ordinarily, accountants would look at this and disallow booking the loss on the tax return because of the wash sale rule. Except bitcoin is not a stock or a security. So the wash sale rule does not apply. This trader should be allowed to claim the capital loss on the sale that occured on February 5th, even though the coins were re-purchased within 30 days.
There is talk among tax professionals whether the IRS will come forth with additional guidance that seeks to make the wash sale rule apply to digital currency transactions. So far, that has not happened, but we’re on the lookout for any changes to this policy.
(This article was originally published in the International Business Times. Photo credit to Marco Verch / Flickr.)
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