Cryptocracy, crypto investment and your taxes: A look at the impact on investors’ taxes

Cryptocracy, crypto investment and your taxes: A look at the impact on investors’ taxes

RALEIGH – In July 2022, Bitcoin, arguably the world’s most recognizable cryptocurrency, fell below $ 20,000. their cryptocurrency holdings from the perspective of how their gains will be taxed. Now that cryptocurrency has fallen in value, we turn our attention to the tax implications of losing cryptocurrency.

Taxation of cryptocurrency

The government taxes cryptocurrency as a capital asset, in the same way as taxing the sale of shares or goods such as gold. This deviation from the namesake of a “currency” seems a little strange. However, cryptocurrency is not something that is traded freely for goods and services, nor does it hold a stable price. Thus, its characteristics are much more in line with a stock rather than a currency.

Consequently, the sale or exchange of cryptocurrency generates a gain or loss for the seller based on the difference between the purchase price and the sale price. For example, if the cryptocurrency was bought for $ 30,000 and sold for $ 40,000, the seller will recognize a gain of $ 10,000 at the time of sale and pay the corresponding taxes. However, if the cryptocurrency were instead sold for $ 20,000, the seller would acknowledge a loss of $ 10,000 at the time of sale.

While a taxpayer must pay tax on the entire capital gain in the year of sale, they cannot immediately deduct capital losses to the same degree. In general, capital losses cannot be used to reduce non-capital income and can only be used to offset other taxable capital gains. However, section 1211 of the Internal Revenue Code allows individual taxpayers to deduct $ 3,000 in capital losses per year to offset other non-capital income. Otherwise, if the taxpayer has capital gains in subsequent years, he or she can offset these gains with the capital losses. Although it is an advantage to be able to offset ordinary income with capital losses, it often takes several years or the realization of another capital gain for many taxpayers to get back the tax benefits of their losses in full.

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What to do if the cryptocurrency is currently in a losing position

Taxpayers can consider three clear options as if they are holding cryptocurrency at a loss:

1. Keep holding. Cryptocurrency is volatile, and it is possible that the value will eventually increase. For example, in 2021, Bitcoin traded for $ 61,000 in March, before falling to $ 31,000 in July, and back to $ 68,000 in November. The US tax code only taxes income when it is recognized, and it therefore does not tax these fluctuations. In a purely tax perspective, it does not cost the taxpayer anything to wait for the possibility that their cryptocurrency will gradually increase in value.

2. Sell. While many investment gurus would recommend never selling low, it is not clear if this is the basement price for cryptocurrency. Therefore, if an investor wants to unload their cryptocurrency, they should consider their inherent tax benefits to sell at a loss. To illustrate this second point, let’s consider a single taxpayer who has $ 100,000 in taxable income each and every year, and this taxpayer recognizes a $ 12,000 loss on the sale of cryptocurrency in the year 2022. The U.S. tax code allows the taxpayer to deduct $ 3,000 of this loss every year. See below for how this loss affects taxpayers’ tax liability for 2022 and beyond:

Without capital loss deduction With capital loss deduction
Year Taxable income Estimated tax liability Taxable income Estimated tax liability Difference
2022 $ 100,000 $ 17,836 $ 97,000 $ 17 116 $ 720
2023 $ 100,000 $ 17,836 $ 97,000 $ 17 116 $ 720
2024 $ 100,000 $ 17,836 $ 97,000 $ 17 116 $ 720
2025 $ 100,000 $ 17,836 $ 97,000 $ 17 116 $ 720
Total savings $ 2880

Source: NCSU

Each year from 2022 to 2025, the taxpayer can deduct $ 3,000 from his ordinary income to lower his tax liability. While it is not ideal to realize a loss of $ 12,000 if the taxpayer believes that the decline in value will persist into the future, going ahead and selling the cryptocurrency at a loss may allow the taxpayer to generate the tax benefits now instead of later, which is preferential. from a present value perspective.

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Finally, cyrptocurrencies do not currently have “laundry sales” prevention rules. This idea allows taxpayers to sell a cryptocurrency, recognize the loss and then immediately buy back the same cryptocurrency, a feature that is not available for other capital assets.

3. Do not donate (directly). As the cryptocurrency flourished, many investors donated the cryptocurrency to reap the tax benefits of an asset that has valued so much in value. However, the same strategy should not be used if the cryptocurrency is in a losing position. Donating cryptocurrency follows similar rules as for securities. The US tax code allows the donation of securities such as shares or bonds at fair market value. Thus, when the security is worth more than what it was purchased for, the taxpayer can donate the security directly to a charity and receive a deduction for the present value of the security while avoiding paying capital gains tax on the gain.

However, the same rules apply if the security is in a loss position, or in other words, the taxpayer will also lose the tax deduction for the capital loss on donation. Thus, taxpayers who want to donate the asset should instead indirectly donate the assets of the charity by selling them first (approve the loss and be able to deduct it from this year and this year, and then donate the proceeds.

This entry was originally posted in Poole Thought Leadership.


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