Cryptos mad dash is giving investors major tax headaches

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Crypto investors who made big profits in 2021 with a big tax bill might be surprised to find out the tax limits of their massive losses from last year.

For example, these losses cannot be used to offset individuals’ prior capital gains, and taxpayers can only deduct up to $3,000 of capital losses per tax year from ordinary income, a deduction that remains not adjusted for inflation. Losses on crypto coins that have lost nearly all of their value cannot be considered “worthless” to take advantage of a securities tax break.

This may leave some investors frustrated with what appear to be arbitrary tax restrictions, especially after paying Uncle Sam last year for 2021 earnings sometimes selling crypto at a loss to foot the bill.

“Fair is just another four-letter F word,” when it comes to taxes, Greg Kling, associate professor at USC Leventhal School of Accounting, told Yahoo Finance.

An editorial photo studio photo of a Bitcoin with some IRS 1040 tax forms.

No postponement

While corporations can retroactively deduct capital losses for the previous three years, individual taxpayers do not have the ability to carry forward investment losses to offset prior gains, regardless of the asset derived from stocks, bonds or crypto.

“You have $100,000 capital gain income in one year and $100,000 loss the next year,” Kling said. “If it was symmetric, we should be able to carry that loss forward. But the tax law doesn’t allow us to do that.”

This is a big deal for crypto investors who had a banner year in 2021, when the cryptocurrency market capitalization hit $3 trillion and bitcoin (BTC) topped $68,000 per coin in 2020. November 2021. Since then, the crypto has lost over $2.2 trillion in total. value, landing the industry in an ongoing crypto winter.

One of Adnan Islam’s clients, not realizing he couldn’t carry over losses, sold his crypto investments at a steep discount just to pay last year’s taxes, the manager told Yahoo Finance. digital currency taxation at Marcum, LLP.

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“How else are you going to pay that tax on the tons of crypto gains you’ve made when all your stuff is stuck in a loss?” says Islam. “You have to sell to get the money to pay the tax.”

Capital loss limits

The $3,000 loss cap and its limits further compound the woes of crypto investors.

The IRS only allows capital losses to be used against ordinary income, think of earned income like wages, salaries, and business income up to $3,000, after capital gains have been offset or eliminated that year.

“If you make $100,000 in realized earnings in a year, you have to report all of that and pay taxes,” Kling said. “But if the next year you have $100,000 in losses and let’s say that’s your only capital trade or trades, you’re limited to $3,000.”

On the other hand, the IRS allows taxpayers to carry forward remaining capital losses indefinitely, with a net capital loss limit of $3,000 per year. This limit applies even if the taxpayer accrues additional capital losses, which would be added to other losses for future use until the deductions are exhausted.

The other downside of the cap rule, which was enshrined in law in 1978, is that it is not adjusted for inflation, a salient factor since consumer price growth peaked. in 40 years last year.

“It would be around $14,000 today with a calculation of CPI inflation,” Annette Nellen, professor and director of the San Jose State University graduate tax program, told Yahoo Finance. But there’s little support for creating the adjustment on Capitol Hill because any increase is going to be a revenue loser, she said.

“Worthless” security deduction

The FTX logo displayed on a phone screen and the representation of cryptocurrencies are seen in this illustrative photo taken in Krakow, Poland on November 14, 2022. (Photo by Jakub Porzycki/NurPhoto via Getty Images)

Taxpayers deducting loss from cryptocurrencies that have imploded in value, such as FTT (FTT), a native currency of the FTX exchange that recently declared Chapter 11 bankruptcy; and Luna and TerraUSD, which both cratered in May, also cannot benefit from the sale under the worthless safety rule.

Tax law states that if taxpayers have securities that became worthless during the year, the full amount of the loss may be recognized as a capital loss that year, even if the investors still hold the security. . The capital loss, however, is still subject to the $3,000 limit.

Experts do not believe this deduction would be allowed for FTT, Luna or TerraUSD because nowhere in IRC 165(g) a tax code that governs the worthless securities rule alludes to cryptocurrency. The code begins with: “If no security,” Islam noted.

“You can just stop reading there,” he said. Crypto “is not security”.

This means the best way for investors to cement losses is to simply sell the cryptocurrency, Nellen said.

“If someone really wants to get the loss,” she said, “they should probably sell it even for its small value to an unrelated person to get a capital loss.”

Rebecca is a reporter for Yahoo Finance.

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