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A graphic image with a person dressed in a suit, holding a box labeled 'LOSS' over their head, which is hidden from view. The box, along with the person's posture, suggests a metaphor for financial loss or the burden of debt. They stand atop a large coin implying monetary concerns, with a background in shades of gold and a hint of a dollar sign. To the left, there's text from CryptoTaxAudit that questions 'Isn't It Time to Increase the Capital Loss Limitation?' and discusses the limitations on capital losses set at $3,000 per year, hinting at the debate over whether this threshold should be raised in light of the significant losses experienced by many crypto investors.

crypto taxes Jul 10, 2023

Capital losses are limited to $3,000 each year. That's peanuts in comparison to the losses that many crypto owners have experienced and could take more than a lifetime of carryovers to claim. Shouldn't it be raised? (TCDS-05)

It's been a few hard years in crypto.

Did you lose money in your crypto or other investing? Can you get a tax break on it?

Currently, there is not much of a tax break. The question is, "should it be changed?"

It's been hard for many crypto investors who have realized many substantial losses. However, the IRS tax code only lets taxpayers deduct a maximum of $3,000 in capital losses for each tax year. If you lost $100,000, like many crypto investors did, it would take you 34 years to recover the loss. And, it could take more than a lifetime if your loss was greater!

A proposal to increase the capital loss limitation.

I propose that Congress increase the capital loss limitation in code section 1211 from $3,000 to $15,000 starting this year and adjust it each year thereafter for inflation. This is what currently happens with the gift tax limit, for example, where the deductible amount has risen from $14,000 to $17,000 over the last decade.

How capital gains are currently taxed.

Let’s review how our capital gains are taxed today. It is a bit convoluted, so here’s a simple summary for crypto investors.

Whenever you sell, exchange, or otherwise dispose of property (like cryptos), you realize a gain or loss. Many crypto investors make the mistake of thinking they are taxed only when they trade for USD. That’s wrong.

Whether you receive fiat, tokens, or stablecoins in exchange for your crypto, they are all taxable events. They are all realized gains or losses.

Unrealized gains and losses are not taxable until they are realized. Gains and losses are realized when you dispose of them.

Disposing on a crypto asset means selling, swapping, gifting, spending, or some other way of using the asset.

How are capital gains calculated?

To calculate your gains, first split your capital gains and losses into short-term and long-term dispositions. Long-term means that your asset was held for more than a year. Short-term means you held it for a year or less.

If the sum of the short-term gains and losses for the year result in a net gain (meaning you made more than your lost), then the net gain is added to your adjusted gross income and taxed at your ordinary tax bracket.

For long-term, net gains are taxed at a lower rate of 15% for most people. The rate of 20% is used for people with taxable income over about half-a-million dollars.

If your capital losses are more than your capital gains, the difference is deducted. The annual limit on the amount of capital loss that can be deducted is only $3,000. Loss in excess of the limit is “carried over” to the next tax year.

Why is there a distinction between short-term and long-term?

Congress created a distinction between short-term and long-term capital gains treatment because they wanted to motivate taxpayers to invest their capital for the long term. Long-term investments tend to better stimulate the economy than short-term investments.

Investing for the long-term is how a well-functioning capitalist economy works.

Business owners and entrepreneurs need the confidence to trust that investors will not pull their funding too quickly. Day traders and short-term traders are seen as not genuinely investing in economic growth, and therefore, are taxed at a higher rate.

Capital loss limitations.

Congress also wanted to offer some tax breaks for investors who tried, who took a capital risk, but lost their money. There are no guarantees in business, so many investments fail, even when well-researched and well-intentioned. So, Congress provided a method to claim losses. Yet, they limited how much loss could be deducted. This limit was intended to avoid rewarding bad investing with tax breaks that were seen as too large.

However, the $3,000 deduction limit hasn't been changed in many years. In fact, this limit is only worth about $800, depending on your tax bracket. An $800 tax credit is puny especially when compared to the Child Tax Credit, where the government gives you $2,000 for having a child.

Maybe the government would rather you make love, not profit.

Back in 1977.

The $3,000 capital loss limit started back in 1977. And, this limit has not been adjusted annually for inflation. If it had, the capital loss limit would be much higher today.

The $3,000 capital loss limit, established in 1977, would be worth about $15,000 today if adjusted for inflation.

That $15,000 limit would be worth a tax savings of about $4,500, depending on your tax bracket. That's far greater than the $800 savings that results for the current $3,000 capital loss limit.

That tax savings would also be much more helpful for middle-income investors, yet not so significant as to distort normal investing behavior.

The CRS report.

The Congressional Research Service (CRS) produced a report in September 2022 recommending that the $3,000 capital loss limit not be changed. They felt that the limit unduly benefited the wealthy.

I think their conclusions were narrow and wrong.

The behavior of the wealthy would not be distorted by increasing the loss limit. The amount of loss would be unchanged. What is changed is how soon the taxpayer can benefit from the excess loss. That's likely to make a much more significant impact for the average investors than the wealthy ones.

Do you think the capital loss limit should be increased?

What do you think? Should the capital loss limit be increased to $15,000 and inflation adjusted each year thereafter? Should the amount be higher, lower, or stay the same?

Ask Congress to act.

If you want Congress to make a change, here is what you can do. Contact both your senators and your congressional representative.

Visit the elected officials site to reach out to them online. (No, you don't have to write a traditional letter. Just fill out a form and file your concern online.)

Just write:

Please increase the income tax capital loss limitation from $3,000 to $15,000 and inflation adjust it each year thereafter. It would help average investors like me.

DISCLAIMER: Opinions and perspectives of the author, host, and guests. It should not be construed as U.S. taxpayer advice. There are often multiple interpretations of tax law. Various strategies may be suited to specific individuals and for particular situations. Seek out professional tax, legal, or financial advice from CryptoTaxAudit or from other reputable companies.

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