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Because of the oncoming winter and the recent bankruptcy of major exchanges, taxpayers are concerned about how to properly report their losses for tax purposes. There is no simple solution since the necessary tax reporting may change based on the specifics of how the loss was incurred.
In the following Q&A, we’ll discuss a few scenarios and the tax reporting postures that would apply to each.
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01. My assets have lost a lot of value due to market circumstances, but I can still make a profit if I sell them. Is it possible to deduct the loss in value of the coins without selling them and thus avoid the associated trading fees? No. Even if losses from a drop in market value are written off according to generally accepted accounting principles (GAAP), the property still needs to be sold for tax purposes. However, “wash sale” restrictions do not apply to digital assets as they do to stocks, so if you change your mind about selling, you may immediately buy the item and “harvest” a tax loss.
02. Does the loss realized comprise the maximum fair market value of the digital asset (“DA”) less the selling price, or is it limited to the DA’s actual cost? No more than the amount actually spent may be lost. If your investment was $1,000, the DA peaked in value at $10,000, and you sold it for $500, the actual loss on sale is $500, not $9,500.
03. The exchange I entrusted to my DA has been frozen and is liquidating its contents. Meanwhile, I have no access to my DA, which have dropped in value but are still available on several exchanges.
Can I take a loss if my cost base decreases? The answer is probably not, since they are still traded on other exchanges despite the frozen one’s shutdown. Until the liquidation is complete and the DA is once again tradeable, you may not be able to calculate your loss.
04. I used a Defi exchange to bet or lend on my Defiant Assets (DA), and now my DA are worthless and cannot be exchanged. How much of a loss should I claim from this loan on my taxes? In the first place, you may be able to deduct bad debts for anything other than a company if the loan qualifies as a short-term capital loss. The yearly limit on deducting such a loss from ordinary income is $3,000, but there is no such limit when it comes to capital gains. Any percentage of a loss carryover that isn’t utilized will be accessible forever. Because these rules are so complicated, it’s important to think about how they apply to you and your situation.
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05. I sold my DA at the peak of the market, and now the market has crashed, making my DA worthless. Trading has been halted as of today. Is it possible to deduct the loss if I assert that the security is “worthless”? A. DA are treated as property, not securities, for tax reasons. The loss cannot be recognized until the asset is “sold or exchanged,” in contrast to securities, which might be considered “worthless” and yet be liquidated.
06. Because of a “hack” that caused the exchange’s assets to devalue, I had to abandon the location where I had been keeping my DA and must now find a new home for it. The liquidation process has begun, and it may be many years before I see a profit.
May I file a claim for a loss due to a casualty or theft? If this is the best course of action is up for debate. Unfortunately, a provision that goes into effect in 2018 and remains in effect until 2025 means that losses from catastrophe or theft that prompted the shutdown of the exchange are no longer deductible under the Internal Revenue Code. When the legislation that previously allowed theft losses to be deducted enters into force again, your loss should become clear and you’ll be able to do so.
7. Following the revelation of the Madoff Ponzi scheme in 2009, the IRS issued a number of Revenue Procedures, one of which permitted ordinary losses to be written off at varied percentages depending on the circumstances. For what reason shouldn’t the current crop be given preferential treatment if recent bankruptcies and “hacks” can get it? A. The victims of Madoff’s scam were the ones who had put their faith in him financially but had subsequently seen him steal from them. Losses from theft could also be deducted in the same way that most other business costs are.
Losses from theft are not deductible under current law until the statute expires in 2025, despite the fact that “hacks” of an exchange in which individual DAs are taken seem to constitute as direct theft.
If an exchange fails because of a lack of capital unconnected to the theft of an individual’s assets, then any losses incurred as a consequence of theft are disregarded as being unrelated to the theft of those assets. Each unique set of circumstances must be carefully examined to see whether tax law could apply to allow any current tax loss.
