Bitcoin Tax on Monopoly board

Deducting Bitcoin Losses From Failed Exchanges

Home » Blog » Deducting Bitcoin Losses From Failed Exchanges

A client asked me recently what the rules are for deducting bitcoin losses following an exchange failure.  Specifically, he wanted to know whether the IRS would accept evidence that he attempted to liquidate his holdings at the exchange in question (a certain high profile Japan-based outfit that shall not be named) as justification to increase his deductible basis to the market value of his bitcoins as of the date that the withdrawal request was denied. The answer is no.

Even if you could do this, you would be required to recognize the gain on the increased basis before deducting your loss for the year.  Therefore, net result would be the same.

This question is important because cryptocurrency investors need to understand how capital losses are calculated in order to make effective tax planning decisions prior to the end of the tax year.  If you are expecting a big capital loss for the year to offset your gains on more successful investments and you base your estimate on a misunderstanding of the law, you might be in for a shock.  Here is a summary of the rules as they apply to bitcoin.

First, according to IRS notice 2014-21, bitcoin must be treated as property by US taxpayers, not as currency.  This terminology can be confusing, since “property” isn’t really a meaningful asset classification for tax purposes.  Virtual currencies, including bitcoin, can either be a capital asset or a non-capital asset, depending on whose hands they are in.  If you are not a professional bitcoin trader or dealer, then your bitcoins will probably be a capital asset to you.  If you think you might fit into this category but aren’t sure, you should discuss with your tax practitioner.

For a capital asset, your basis is equal to the amount that you paid to acquire the asset.  For example, if you paid $500 for 1 bitcoin, then your basis is $500, regardless of how high or how low the price of bitcoin moves.

When you dispose of a capital asset (usually by selling, but also by exchanging for something else that isn’t like-kind), you recognize either gain or loss equal to the difference between your basis and the market value at the time of the disposal.  For nearly all US taxpayers, the market value reflected by your records must be expressed in US dollars.  For example, if you sell your bitcoin with a basis of $500 for $550, you recognize a gain of $50.

Gains and losses are recognized for tax purposes when realized.  This means that they must be declared in the year that they occur.  If you discover a loss due to casualty (ex. flood damage destroys a paper wallet) or theft, then the loss is deductible in the year discovered.

The character of the gain or loss depends on the holding period for the asset.  Generally, a holding period of less than one year results in short term gain or loss treatment.  A holding period of one year or more results in long term characterization and more favorable tax treatment (i.e. a lower tax rate).

“Them’s the rules” as they apply to bitcoin.  They sound a lot like treatment for stocks, mutual funds, and the like, don’t they?  Well, they should.  That’s because the rules aren’t just similar, they are identical.  Bitcoin may be a technical and social triumph, but it is still just a capital asset to the IRS.

Similar Posts