It was not that long ago that cryptocurrency investors were counting their gains and worrying about their tax bills. Back then, both early adopters and latecomers were being handsomely rewarded, with new all-time highs coming on a daily, and sometimes on an hourly, basis.
If you were lucky enough to sell some of your Bitcoin, Ethereum, Litecoin, and other cryptocurrency holdings while prices were at all-time highs, you may well be dealing with those IRS issues. If not, you are probably licking your wounds and wishing that your crystal ball was in better condition.
Even so, those mindboggling losses could have a silver lining. The cryptocurrency market may have crashed from its historic highs, but smart investors could use those losses to lower their tax bills and book some savings.
Should You Turn Paper Losses into Real Ones?
Anytime you invest in an asset, be in a share of stock or a virtual coin, you need to have an exit strategy. That means evaluating the amount of risk you are really willing to take, and how much pain you can withstand before it is time to sell out.
When it comes to cryptocurrency investing, those considerations can be even more extreme. As Bitcoin fans have found out, the same currency that sold for nearly $20,000 apiece not long ago is now priced at just over $4,000. Even the wildest stock market rollercoaster does not have hills and valleys that steep, and that creates a real conundrum for new and old investors alike.
Before you make a move, you need to look at how much you have in the cryptocurrency market, how much of that money you can afford to lose and what you want to do going forward. Can you afford to hold on through the current bear market, or is it time to recapture your money while you can? The decision to turn paper losses into real ones is always difficult, but the ability to harvest tax losses could soothe some of your financial pain.
Sound Advice and Good Recordkeeping
If you do decide to sell your cryptocurrency holdings, it is important to research the tax implications. If you were one of those aforementioned early adopters, you may still have some substantial gains, even in the face of the current vicious bear market.
Investors who jumped into the cryptocurrency pool a bit later, losses are far more likely. But by harvesting those gains, cryptocurrency fans could lower their overall tax bills and recover at least some of the money they have lost.
The tax rules surrounding cryptocurrency are complicated, and it may be a good idea to get professional help with your return. Even if you have always done your own taxes, seeking out a tax professional with cryptocurrency expertise could be worth your while, especially if your holdings, and your losses, are substantial.
Whether you prepare your own tax return or seek the advice and guidance of a professional, good recordkeeping is essential. Cryptocurrency transactions can get pretty complicated, especially if you have made purchases and sales along the way. The better your recordkeeping, the easier it will be to determine how much you have made, or lost, on your Bitcoin, Ethereum and other virtual holdings.
If you have moved your cryptocurrency holdings to cold storage, hopefully, you kept careful track of every purchase, sale and other transaction. It is important to keep this information safe, just like you do with your private key.
Things may be simpler for investors who kept their cryptocurrency holdings on an exchange. The exchange should have records of the purchases they made, the coins they redeemed and other pertinent information. If you keep your coins on an exchange, your first step should be tracking down this vital information.
How the IRS Views Cryptocurrency Losses
IRS rules treat cryptocurrency investments as property, subjecting the virtual coins to taxation under the capital gains section of the tax code. If you are lucky enough to have a gain in your cryptocurrency account, you will have to pay taxes on that gain, and the amount you pay will depend on how long you have held the investment.
If you have held your cryptocurrencies for less than one calendar year, you will pay taxes at a rate equal to your regular tax rate. For holdings over a year, the tax rate is capped, with the cap determined by your income. For most taxpayers, the top capital gains rate for cryptocurrency holdings will be 15%.
If you have losses instead of gains, something increasingly likely in the current bear market, you can use those losses to offset other gains in your portfolio. If you had a good run in the stock market, the losses you incur in your Bitcoin holdings could lower the amount of capital gains you have to pay.
For investors with larger losses, the tax savings could roll over from year to year. If your cryptocurrency losses exceed the amount of your capital gains, you can use the loss to reduce your taxable income, up to a current limit of $3,000. If your losses are higher than that, you can roll the amount forward, offsetting additional income and capital gains in the coming years.
Whether your foray into the world of cryptocurrency was a profitable endeavor or a painful experience, it is important to stay on the right side of the IRS. After years of nearly ignoring these alternative forms of payment, the tax agency is making up for lost time – and looking for taxpayers who fail to report their holdings.
If you hold virtual coins in your portfolio, or if you have sold virtual assets, you need to report that information to the IRS. For some investors, that may mean reporting a loss, but the ability to write off part of the money could ease the pain. In the end, the experience could leave you a wiser cryptocurrency investor.