On October 31, 2008, the person (or persons) going by the name of Satoshi Nakamoto first posted the paper titled, “Bitcoin: A Peer-to-Peer Electronic Cash System.” Within months, the first Bitcoin had been “mined” setting off a technological and cultural revolution. And over the next decade, Bitcoin and other cryptocurrencies would see a dramatic rise in distribution and price, culminating in an epic 2017 that saw the value of many cryptocurrencies grow by more than 1,000%!
Unfortunately, just as public infatuation with cryptocurrencies seemed to reach a peak, so did its price, leading to a disastrous 2018. During the year, many cryptocurrencies lost upwards of 80% of their value, leaving investors with sizeable losses, and questions about what to do, if anything, to make the most of their losses (at least from a tax perspective).
Fortunately, to that end, back in 2014 the IRS released IRS Notice 2014-21, providing its first substantive guidance on the taxation of Bitcoin and cryptocurrency transactions. Notably, the IRS determined that cryptocurrencies are “property” for Federal tax purposes, and not currency. Thus, the sale of cryptocurrency results in capital gains and losses, rather than ordinary income.
In general, the basis of a taxpayer’s cryptocurrency is the price paid to acquire the currency (in U.S. dollars) from its previous owner, typically via an exchange. In other words, the basis of an investment is what you paid to acquire it. In the context of cryptocurrency that is mined, though, there is no “purchase” transaction in the first place. Instead, the act of mining itself is treated as an income-producing activity, such that the fair market value of the cryptocurrency is included in gross income when it is mined. In turn, that fair market value becomes the miner’s cost basis in the cryptocurrency property going forward.
For taxpayers who liquidated cryptocurrency positions at a loss in 2018, the “planning” options are unfortunately somewhat limited. At this point, the best that can be done is to use any 2018 cryptocurrency losses to offset other 2018 capital gains and up to $3,000 of ordinary income. Any additional (cryptocurrency and other capital) losses must be carried forward for use in future years.
Taxpayers who currently hold cryptocurrency positions with unrealized losses can still choose to liquidate those positions in 2019 and use those losses to offset other portfolio gains (e.g., enabling investors to minimize the impacts of rebalancing out of other investment positions that have accrued substantial capital gains).
Unfortunately, though, harvesting cryptocurrency capital losses may be easier said than done, particularly for long-term cryptocurrency investors whose early purchases have accumulated in value, as FIFO tax treatment for multiple lots of cryptocurrency is likely required. On the other hand, because cryptocurrency is “property” but not (at least at this point) treated as an investment security, it appears the Wash Sale Rule does not apply to sales of cryptocurrency. Thus, positions with losses can be sold in order to be able to use the loss for planning today (or to “bank” the loss for future use), and still repurchased shortly thereafter (for those who want to continue to HODL), enabling the investor to continue to participate in future appreciation (at least if they’re still optimistic about cryptocurrency investment potential in the first place).
Finally, it’s worth noting that the digital nature of cryptocurrency makes it more susceptible to theft-by-hack (or other means), while its ethereal nature makes it more likely to be truly lost (via lost keys or cold-storage hardware) than other assets. Which is important because unfortunately, such losses would be treated as casualty losses which, after the Tax Cuts and Jobs Act, are generally no longer deductible at all!
Many crypto-advocates believe its long-term growth potential and viability as an asset class remains strong. Nevertheless, many investors first entered into the crypto-game in 2017 – when interest in the asset class grew exponentially due to its dramatic rise in price – and are now left trying to make the most of their losses.