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Are you one of the many crypto investors who suffered significant losses in the past year? Perhaps you invested in Bitcoin or Ethereum, only to see your holdings plummet in value. Or maybe you tried your hand at some altcoins that have since become virtually worthless. Whatever your situation, you may be wondering if there is any way to recoup your losses when tax season rolls around the corner.

Fortunately, there is a way you can claim tax losses on worthless crypto - but it's not as straightforward as you might think. In this blog post, we'll explore the ins and outs of claiming losses on “worthless crypto”. We'll examine the IRS Chief Council Memorandum 202302011, which outlines the circumstances under which you can take this step, and offer some tips for making the most of these tax deductions.

Whether you're a seasoned crypto investor or a newcomer to the scene, read on to learn more about how to minimize your tax burden and potentially recoup some of your losses.

Decoding the IRS's Recent Memorandum

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As per the recent IRS memorandum discussed in the introduction, if you buy a crypto and its value goes down significantly, you might be able to get tax deductions for the capital loss.

Here's an example to help understand it better. Let's say someone named Sarah bought some Crypto A for $1.50 per unit in 2022 for her personal investment on a crypto exchange. But by the end of the year, the value of each unit had gone down to one cent.

Even though Sarah could still sell, exchange, or transfer the crypto on at least one exchange, she didn't get rid of them or abandon them in 2022. Because of this, the IRS considers that Sarah didn't actually lose anything under Section 165(a), so she can't claim a loss on her taxes.

To put it simply, if you buy crypto and its value goes down, you may be eligible for tax deductions for the loss. However, to claim these deductions, you must dispose of or abandon the crypto. If you don't take any action to get rid of it, you won't be able to claim the loss on your taxes.

Deductions on Worthless Crypto

The IRS memo doesn't give explicit instructions on how to claim deductions for crypto that have lost significant value or become worthless, but there are general tax rules according to IRC Section 165(G) that allow you to report a capital loss as long as you dispose of the crypto properly, and there is at least one market where it has liquidity.

For instance, you invested $500 in a new crypto called "Mooncoin" in 2021, and it grew in value to $50,000 by mid-2022. However, by the end of 2022, its value had plummeted to just 50 cents. If you sell Mooncoin on a market where it has liquidity for 50 cents, you can claim a capital loss of $499.50.

But just holding onto the Mooncoin and considering it worthless doesn't count as a loss for tax purposes. You must also remember to claim your capital loss deductions, you need to meet two requirements:

1. The loss must occur during the tax year that you're filing for. In simpler terms, you can only claim the loss if it happened within the same year as your tax filing.
2. The loss must be directly evidenced by closed and completed transactions, fixed by identifiable events. This means that you must be able to show that the loss happened due to a specific event, rather than something more general.

How To Claim Tax Loss On Worthless or Abandoned Crypto?

Here’s a step-by-step method to claim your tax losses on worthless or abandoned crypto.

Step 1: Determine the Cost Basis of Your Crypto

The cost basis is the original value of the crypto when you acquired it. You will need to determine the cost basis of your crypto in order to calculate your losses. If you acquired the crypto through a purchase, the cost basis is the purchase price. If you acquired the crypto through mining or other means, the cost basis is the fair market value at the time of acquisition.

Step 2: Determine the Fair Market Value of Your Crypto

You will also need to determine the fair market value of your crypto at the time it became worthless or was abandoned. This is the amount that the crypto would have sold for if it were sold on the open market at that time.

Step 3: Calculate Your Loss

To calculate your loss, subtract the fair market value of the crypto at the time it became worthless or was abandoned from the cost basis of the crypto. If the result is a negative number, you have a loss.

Step 4: Complete IRS Form 8949

You will need to report your loss on IRS Form 8949, which is used to report sales and exchanges of capital assets. You will need to complete Part I of the form, which asks for information about the asset that was sold or exchanged, including the date acquired, the date sold or exchanged, the sales price, and the cost basis. You will also need to report the amount of the loss on the form.

Step 5: File Your Tax Return

You will need to file your tax return and include a copy of IRS Form 8949 with your return. Make sure to include all other required forms and schedules with your return as well.

It's important to note that the IRS treats crypto as property for tax purposes, so losses on crypto are treated the same as losses on other types of property. Also, it's always a good idea to consult with a tax professional if you have any questions about how to report your losses on your tax return.

FAQ

1. Can I deduct losses from my crypto on my tax return?

Yes, you can deduct losses for crypto on your tax return. If you purchase cryptocurrency and subsequently experience a significant decrease in its value, you may qualify for a tax deduction in relation to the loss incurred. However, to claim such a deduction, it is necessary to dispose of or abandon the cryptocurrency. Failure to take action in this regard will result in disqualification for the deduction on your tax return.

2. Are there any requirements for deducting a loss from my crypto?

If you wish to claim deductions for losses on your taxes, you must keep these two avenues in mind: 

a. All transactions must be incurred within the current year and 

b. They must be traceable to a distinct and identifiable event that has concluded or been resolved. 

In simpler terms, you can only deduct losses if they are clearly linked to a specific event and have taken place during the current tax year

3. What IRS may ask to prove for abandoned crypto loss claims?

Abandonment of property is proved by examining the context and conditions surrounding the situation, which should demonstrate a two-fold factor: 

a. the intention to abandon the property, and

b. an affirmative act of abandonment.

An affirmative act refers to a deliberate action taken by the taxpayer to discard the property entirely. Mere intention or non-use of the property does not suffice as proof of abandonment. It is necessary to provide clear and explicit evidence of abandonment

4. Are there any limitations on the amount of losses I can deduct from my crypto?

According to Section 1211 of the Internal Revenue Code, there's a limit to the number of losses you can deduct each year. For individuals, the cap is $3,000, and $1,500 for married couples filing separately.

But don't worry, there's still hope for those who have losses exceeding this limit. Section 1212 allows taxpayers to carry forward these excess losses to future tax years. So keep track of your cryptocurrency transactions and losses, as accurate record-keeping is essential to properly report capital gains and losses on your tax returns.

5. Can I offset worthless or abandoned crypto against capital gains?

Yes, according to the IRS, if you sustain a loss due to the abandonment of a cryptocurrency, it would be treated as a capital loss under I.R.C. Section 165(a). This means that you can use the loss to offset capital gains, but not other types of income.

It's important to note that in order to claim a loss on abandoned cryptocurrency, you must be able to prove that the crypto has become completely worthless and that you have no hope of recovering any value from it in the future. Additionally, you should consult a tax professional for guidance on how to properly report these losses on your tax return.

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All content on Kryptos serves general informational purposes only. It's not intended to replace any professional advice from licensed accountants, attorneys, or certified financial and tax professionals. The information is completed to the best of our knowledge and we at Kryptos do not claim either correctness or accuracy of the same. Before taking any tax position / stance, you should always consider seeking independent legal, financial, taxation or other advice from the professionals. Kryptos is not liable for any loss caused from the use of, or by placing reliance on, the information on this website. Kryptos disclaims any responsibility for the accuracy or adequacy of any positions taken by you in your tax returns. Thank you for being part of our community, and we're excited to continue guiding you on your crypto journey!