Can You Deduct Worthless Crypto On Your Tax Return? 

Did your crypto investment run off to the Bahamas with the owner of FTX? One of the top questions asked this tax season was whether people could offset the loss of cryptocurrency. Many may have felt like their hands were tied, however the government recently made a ruling on what to do with all that worthless crypto.

Like all things involving taxes, the ruling is situational. If your loss wasn’t compensated by insurance or other means, the IRS lets you write it off with some caveats.

There are three areas in which the IRS made a decision:

  • Capital loss
  • Worthless security deduction
  • Abandonment loss

Capital Loss

A capital loss occurs when there is a “sale or exchange” of a capital asset at a loss. So say you buy a house for $250,000 and sell the house five years later for $200,000. You realized a capital loss of $50,000.

To meet this requirement, though, you have to sell your asset. Which means there has to be a market for your cryptocurrency to be able to have it sold, which is not the case for some of the more volatile crypto currencies anymore.

If you’re thinking of selling your crypto or have already sold it, it’s worth talking to your tax professional about writing it off as a capital loss.

Security Deduction 

Since an asset has to have value to claim it as a capital loss, some may wonder if they can write their worthless crypto loss off as a worthless security deduction. 

Unfortunately, the IRS stresses that even though the coin is totally worthless, it is not eligible for the worthless security deduction because cryptocurrency doesn’t meet the definition of a “Security” for tax purposes.

Abandonment Loss

There could be rare situations where you may not have any access to a liquid market to dispose of your coins and claim a capital loss. In such cases, abandoning the asset could still be a path to a deduction. This one is complicated, but could work for some of you out there. 

First, the losses must meet four criteria:

  • It occurred in a trade or business.
  • It was part of a transaction that you entered into for profit.
  • It happened to a non-depreciable property.
  • The loss was a result of a theft or a “casualty” event.

The IRS has determined that cryptocurrencies are non-depreciable property, which is the good news. But proving you had a “transaction entered into for a profit” and permanently discarded the asset may be challenging for crypto transactions.

Does a market crash count as a casualty event? According to the IRS, a casualty is a sudden, unexpected, or unusual event, such as a fire, storm, flood, or earthquake, that causes damage to property. So, this is still up in the air.

Crypto is still new, so there’s a lot that the IRS is still developing. If you have a loss, it’s worth meeting with your tax professional to see the best route for you.

If you still have questions, contact Paragon today!