TAS Tax Tip: When Can You Deduct Digital Asset Investment Losses
October 19, 2023 – In the current digital asset climate of plummeting values, frozen accounts, and bankruptcy filings, if you own investments in digital assets, such as virtual currency, cryptocurrency and/or non-fungible tokens (NFTs), you might wonder when it is appropriate to report losses on your tax return.
In the current digital asset climate of plummeting values, frozen accounts, and bankruptcy filings, if you own investments in digital assets, such as virtual currency, cryptocurrency and/or non-fungible tokens (NFTs), you might wonder when it is appropriate to report losses on your tax return.
The IRS considers digital assets to be property. The tax treatment of a digital asset transaction depends on the purpose of the digital asset in your hands. If you held or are holding digital assets as investments, the digital assets are considered capital assets and certain tax rules apply when determining gains and losses from these investments. (Note: This Tax Tip only addresses digital assets held for investment. If you held digital assets for a reason other than investment purposes, see IRS Publication 544, Sales and Other Dispositions of Assets, and IRS Notice 2014-21 for more information.)
Sales
If you sold the digital asset you held as an investment for less than your cost to purchase it, you have a capital loss. First, you will need to determine if your capital loss is a short-term loss or a long-term loss (use IRS Publication 544, Sales and Other Dispositions of Assets, to help you make this determination). Then use Form 8949 to calculate your capital gain or loss and report that gain or loss on Schedule D (Form 1040). If you exchanged your digital asset investment for property (including a different digital asset) other than cash, you will first need to value the property you received on the date of the transaction. For example, if the value is greater than your cost in the digital asset you gave up, then you have a capital loss, which you will report on Form 8949.
How should you report your digital asset investment loss when it is worthless, near worthless, locked in bankruptcy proceedings, or has vanished?
Bankruptcy and Frozen Accounts
Although some digital assets lost a significant amount of their value during 2022, you cannot claim a loss from this decrease on your tax return until there is a closed and completed transaction, such as a sale or exchange. If your digital asset investment account is frozen or your digital assets are tied up in bankruptcy proceedings, you can’t claim a taxable loss because you don’t have a closed and completed transaction. Once your account has been unfrozen or the bankruptcy proceedings completed, you will have to reassess your situation. If your digital assets and your ownership of them have remained intact, and they have any value, then you don’t have a recognizable loss. If you received a settlement (regardless how small) from the bankruptcy proceedings in exchange for your digital assets, this is considered a sale and you should calculate your capital loss (or gain) on Form 8949 and report it on Schedule D (Form 1040) for the year you received the settlement. If you received nothing from the bankruptcy settlement, neither money nor your digital assets, then your digital asset investment may be considered worthless and different rules apply.
Worthless or Abandoned
Unlike a sale of a digital asset investment that results in capital gain or loss, the loss from your digital asset investment becoming completely worthless is an ordinary loss. You should note that the asset must be completely worthless, not nearly worthless, for this loss to recognized. An ordinary loss from a worthless or abandoned investment is a miscellaneous itemized deduction in the year of worthlessness/abandonment but is not deductible on your tax return because the Tax Cuts and Jobs Act of 2017 disallows miscellaneous itemized deductions for tax years 2018-2025.
Theft
If your digital asset investment was stolen, then the theft loss rules apply to the year you became aware of the theft. (see Chief Counsel Advice (CCA) 202302011 and Tax Topic No. 515 Casualty, Disaster, and Theft Losses for more information). The theft must meet your local jurisdiction’s definition of theft and you must include any consideration you received for the theft when calculating your loss (or gain). If the theft results in a net loss, the loss is an ordinary loss and is not subject to the miscellaneous itemized deduction limitations. You will report the gain or loss from the theft of your digital asset investment on Form 4684 (see IRS Publication 547 for more information).
Conclusion
The main point to remember is that not all losses are equal, and the tax treatment depends on the nature of the loss. If you think you have a loss on your digital asset investment, do your homework or consult with a knowledgeable tax professional to help you determine if you’ve incurred a loss on your digital asset investment and, if so, when, to what amount, and the character of any loss (or gain).
If you received a Form 1099 reporting your digital asset income and/or transactions, this information has been reported to the IRS. Make sure to report this information on your tax return, even if your account with the digital asset exchange has been frozen or the digital asset exchange is involved in bankruptcy proceedings.
IRS Resources
Chief Counsel Advice (CCA) 202302011 – Addresses a situation in which a taxpayer did not sustain a loss due to worthlessness or abandonment of cryptocurrency that had declined in value.
IRS Notice 2014-21 – Addresses how existing general tax principles apply to transactions using virtual currency.
Frequently Asked Questions on Virtual Currency Transactions
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