Note: Canby Financial Advisors cannot provide personalized advice or guidance or answer questions about cybercurrency or digital assets. This article is provided for general informational purposes only and does not constitute either tax or legal advice. For any tax-related questions, please speak with a tax professional.
Very few asset classes posted gains in 2022, and cryptocurrency investors were among the hardest hit. By year-end, the two biggest cryptos, Bitcoin and Ethereum, dropped by more than 60% from their 2021 highs.
If you were one the unlucky ones who got on the crypto bandwagon at its peak and jumped off before year end, there’s one little bit of good news to consider while you’re licking your wounds: You can use your crypto losses to offset realized capital gains in your taxable investment accounts.
With the market down last year, you might think that capital gains aren’t an issue, especially if you didn’t sell any investments at a profit.
But if you own equity mutual funds, chances are that some of them did declare capital gains distributions in November or December, even if they posted negative returns for the year. By law, these funds have to pass on these capital gains to shareholders.
So where does crypto come in?
Even though crypto isn’t regulated like stocks, bonds or mutual funds, any gains or losses generated through a sale are treated the same as capital gains or losses by the IRS.
The difference is how these gains or losses are reported. Investors must report them on their tax returns using IRS Form 8949. This form is similar to IRS Form 1099-B, which you receive every year from your custodian or brokerage company to show reconciled gains or losses from the sale of investments.
On Form 8949 you’ll need to enter the name of the crypto, when you bought it, how much you paid for it (the cost basis), when you sold it, how much you sold it for and how much you gained or lost in each transaction.
Depending on how many times you bought and sold crypto several times during the year, gathering and reporting this information may be quite complicated, depending on how and where you conducted your transactions.
Some online brokerage trading apps include listings of gains and losses for crypto transactions in the 1099-B forms they provide to investors. (Note: Most traditional discount brokers don’t yet allow investors to buy and sell cryptocurrencies and most financial advisors won’t manage investments in crypto for their clients.)
Most U.S. investors, however, buy and sell crypto through cybercurrency exchanges. Some of these exchanges may provide you with a 1099-B form that lists all of your transactions. It’s then up to you (or your tax professional) to re-enter this information onto IRS Form 8949.
If they don’t provide 1099-Bs, you may have to manually download all your transactions and figure out how to report them on their your own or let your tax professional do it. (Starting with the 2023 tax year, the IRS will require all US-based crypto exchanges to provide 1099-B forms.)
Leveraging crypto losses to lower your tax bill
If your crypto trading activities resulted in a net capital loss, you can use all or some of these losses to offset realized capital gains from the sale of other investments or capital gains distributions from mutual funds.
More good news: If your total realized capital losses from all sources were higher than your realized capital gains in 2022, you can deduct up to $3,000 of your losses from your ordinary income and then carry any remaining losses forward on your tax return to offset future realized capital gains.
If you didn’t sell any crypto last year, you can apply this same strategy in 2023 and beyond if you want your losses to offset any capital gains realized during the same tax year.
Wash sale rules don’t apply-yet
One potential advantage crypto traders currently have over stock traders is that transactions aren’t subjected to IRS wash sale rules.
These rules state that once you sell an SEC-registered security (like a stock, mutual fund or ETF) at a loss you must wait at least 30 days before buying that same security or fund again. If you don’t, the IRS will consider this a wash sale and your capital loss won’t count.
Since cryptocurrency isn’t regulated by the SEC, IRS wash sale rules don’t apply--yet. You can sell crypto at a loss and then buy it again the next day and that initial loss will still be valid.
Enjoy this freedom while it lasts. At some point the SEC will start regulating cryptocurrencies. When that happens, crypto transactions will be subject to wash sale rules.
If you’re unsure of how to categorize or report capital gains and losses from your crypto transactions, seek the assistance of a qualified tax professional.
This article was authored by David Jaeger and Jeffrey Briskin. David is a financial advisor at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or firstname.lastname@example.org. Jeffrey Briskin is Director of Marketing at Canby Financial Advisors.
©2023 Canby Financial Advisors.