by Clinton Donnelly LLM EA, founder and president of CryptoTaxAudit
Year-end is an important time in the tax world. It’s your last chance to make moves to improve your tax situation before the year ends.
Crypto Tax Volatility
The year 2022 has been quite a year. We started the year in a bear market. Throughout the year, most crypto valuations continued to drop. The Terra LUNA cryptocurrency, along with its TerraUSD stable coin, collapsed in May. The Celsius exchange collapsed in June. And FTX, the exchange led by Sam Bankman-Fried, collapsed in November. A “crypto contagion” then took hold causing interrelated firms like Alameda Research, Genesis Trading, and BlockFi to halt operations and seek bankruptcy protection.
These massive collapses in the crypto industry have dried up new investment, scared retail traders, and removed billions of dollars of value from crypto wallets. And, many investors in these companies lost access to their cryptos, at least for now. People new to cryptos may think that this will all be resolved shortly, but maybe not.
For comparison, after years of court proceedings for the MtGox crypto exchange collapse that occurred in 2014, their crypto claim review process is still underway. That’s eight years later!
It’s Already Year End
All this is happening at the end of a year. This has some crypto holders wondering what they should do, if anything, to improve their crypto tax liability for 2022, especially if they saw some gains earlier in the year. Once the year ends, it will be too late to make any substantial changes.
Here are three things that you can do as a U.S. taxpayer before the end of the year that may improve your tax situation.
Claim Your Capital Losses
If you have significant crypto losses, you can use a strategy called tax loss harvesting. This strategy isn’t just for crypto. It’s used in traditional financial markets as well.
Tax-loss harvesting is simple:
- First, sell a crypto that has lost you money.
- Second, use the capital loss to offset your capital gains this year. You can offset all your capital gain with capital losses up to a total net capital loss of $3000 per year.
- Third, reinvest the money into another crypto or simply hold the funds to invest later.
Any capital losses that you can’t claim this year can be applied against capital gains in future years, gains that many crypto investors expect to see in the years ahead.
Sell and Buy Back
Iif you still want to hold a specific crypto, but saw its value drop dramatically, you can sell it now and buy it back immediately. That strategy harvests the capital loss for the year but preserves your investment portfolio. (see footnote 1)
Get Your Trade Reports
Proper crypto tax reporting requires accurate data. These historical trade reports are provided by crypto exchanges and other centralized crypto trading platforms. However, as many people have realized with FTX recently, if a platform goes down, you don’t just lose access to your crypto. You lose access to your trade history.
If you haven’t already done so, download all the trade reports from the exchanges you used this year. If you can’t get a report, you may have to assemble the data from other sources. You may need to look at trading notes you may have. You may even need to estimate your trades from memory. (see footnote 2)
That situation isn’t ideal, so consider this a learning experience. We always advise our clients to capture their trade reports frequently, either quarterly, monthly, or more often depending on how often you trade cryptos.
A Learning Experience
For most crypto investors, this has been a painful time. The markets have dropped 80% from their all-time highs. Large crypto exchanges and other centralized financial institutions have failed.
And, for some, their individual cryptocurrencies have been seized, whether by fraud, theft, or mismanagement. The courts will try to figure that out in the future.
Crypto experts have been warning investors for years to take custody of their own cryptos. This means taking your cryptos off the exchanges and storing them securely under your own control. It takes a little extra time and effort, and some education to be sure, but this crypto contagion has reminded people that if you don’t control your crypto keys, you don’t control your cryptos.
Defend Yourself Today
Regardless of your reporting strategy, nothing completely protects you from an IRS audit. The exact method for determining who is selected for an IRS audit is a closely guarded secret. So, you need proper defense.
Founded in 2015, CryptoTaxAudit defends crypto traders and investors during IRS crypto tax audits, appeals, and when necessary, in tax court. The company has an experienced team of crypto tax experts including CPAs, enrolled agents, forensic accountants, and gain calculation staff.
CryptoTaxAudit protects its clients with Audit Defense, its flagship membership service. Audit Defense was created in response to the growing cost of defense against the virtually unlimited IRS enforcement budget and the IRS’ tenacious focus on crypto owners.
All opinions expressed should not be construed as tax, legal or financial advice. Seek out the professional legal, tax, and financial guidance and advice that you need for your unique situation, either from CryptoTaxAudit, or from other reputable companies.
1 Tax code section 1091, called the Wash Sale rule, denies the taxpayer the capital loss if the stock or security is repurchased 30 days before or after the sale. This is a harsh penalty on taxpayer behavior. This code section specifically applies to “stocks or securities”. The IRS has offered no guidance if this rule would extend to digital asset transactions. The 2021 Build Back Better Act (not approved) included a proposed law to specifically extend the wash rule to digital assets. Though never voted on, this would suggest that Congress doesn’t assume that section 1091 applies to digital assets already.
2 Tax code section 6001 places on the taxpayer the burden of keep adequate records to substantiate the tax implications of any transaction or deduction. Most traders trust this responsibility to the exchanges but this isn’t a good strategy if audited.