If you're one of the many digital currency investors who've had serious hits to their finances in recent years, there are some tips that can help you take those losses and turn them into tax savings. If you act fast, you can use them to lower your tax bill this April and in the future, too.
Taxpayers are allowed, according to Internal Revenue Service law, to use losses in cryptocurrency and in any stock investments to offset any gains they might have made from similar investments. What does that actually look like?
Say you bought $10,000 of stock in a brewpub startup in your neighborhood, and the business is already making money. Your stock went up in value, so you sold it and made a $5,000 profit.
At the same time, you invested $5,000 in a crypto coin, but its value dropped to $1,000, so you sold it. That's a $4,000 loss – painful but not a total tragedy, because you can lessen the hurt. Those losses can be used to offset your profit on the brewpub stock, so you have less capital gains to pay tax on.
$5K of profit minus $4K of loss, means you'll pay tax on only $1,000 of profit.
The IRS will let you deduct losses from your taxable income if they are greater than profits you made on investments, but only up to $3,000. If you instead had made $3,000 profit on that brewery stock but lost $6,000 on a crypto investment, you would have enough loss that could both offset your capital gains and deduct losses from your taxes. And both are allowed.
In this case, the crypto loss would offset the full $3,000 of profit, bringing your capital gains to $0, so you'd have nothing to pay tax on. That remaining $3,000 of losses can then be deducted from your taxable income. Just remember that $3,000 is the maximum loss that can be deducted in a given year.
If you have investment losses that are bigger than $3,000, you can deduct them up to that $3K limit for the year and then carry the rest forward to the next year – and to the year after, if need be, basically until you die.
If your profit on the brewpub stock was still $3,000, but you lost $10,000 on a crypto currency investment, you would offset the $3,000 profit and deduct the $3K limit as in the previous example. That still leaves $4K of losses that you can't use to offset and you can't deduct this year.
But you can deduct that $4K from your taxable income over the course of the next two years. Next year, you can deduct the $3K limit again, and the year after that, you can deduct the remaining $1,000.
In order to use your crypto losses to offset your capital gains and pay less tax, or deduct them from your taxable income, you have to sell them. It's not enough for the cryptocurrency to have just dropped in value. You need to actually take the loss, or you can't use it in the ways listed above.
Taking a loss on an investment can hurt your pocketbook as well as your confidence as someone who invests their hard-earned money. Fortunately, those losses don't have to be a total, well, loss.
For more tax hacks and workarounds, consult FlyFin CPAs who specialize in 1099 taxes, available 24/7 in the app, and use A.I. to find every possible deduction automatically.
FlyFin CPA Team
With a combined 150 years of experience, FlyFin's CPA tax team includes tax CPAs, IRS Enrolled Agents and other tax professionals, offering users the most comprehensive tax advice and preparation.