It is nerve-wracking to experience crypto volatility, and it may not end soon. This turmoil could make crypto investors less optimistic than they were when crypto prices were rising. You can claim large losses on your taxes due to the market plummeting. Not necessarily. It is worth looking into whether you could make lemonade out of your tax losses as your dollars move around in the digital world.
Ask your tax advisor what has happened. First, consider whether your taxes can be paid for gains that you have already earned this year, if you’ve been trading big taxable gains and then suddenly the floor drops out. Unless you have chosen otherwise, taxes are generally calculated annually and are based on the calendar year. The transaction is taxable if it involves the sale or exchange of cryptocurrency for cash, another cryptocurrency or goods or services.
This is due to the U.S. Internal Revenue Service’s announcement in Notice 2014-21 that crypto is now property for tax purposes. The IRS will require you to report any gain or loss, and not currency, nor securities.
Similar: What you need to know and fear about the new IRS crypto tax reporting
Many crypto investors believed that crypto-tocrypto trading was tax-free before 2018. This argument was based upon section 1031 of tax code. It was an argument that could be used depending on the facts and how the reporting was done. That argument was dropped in 2018! The tax code’s section 1031 now states that it applies only to real estate swaps.
Some pre-2018 crypto taxpayers are being audited by the IRS. The IRS doesn’t seem to like the 1031 argument. Even the IRS released one piece of guidance stating that tax-free cryptocurrency exchanges don’t work. If the IRS pushes this further, it may be necessary to bring it before a judge. It only covers 2017 and previous years so it is of decreasing importance.
However, regardless of whether you use cryptocurrency to pay someone, trade crypto or sell it, will you still have gains or losses. Gains or losses for most people would be subject to capital gains or losses based on the basis (what was paid for the crypto), holding period and the price at exchange or sale. However, some people might experience ordinary gains and losses. This topic is worth revisiting. Do you trade in crypto as a business venture?
Similar: Debunking the major tax myths surrounding cryptocurrency
Investors want long-term capital gain rates for gains when they purchase and hold assets for longer than one year. For losses, however, ordinary income treatment may be beneficial for some. However, securities traders are allowed to make a section 475 mark–to-market election. Does that apply for crypto? It is not clear. It is necessary to argue that crypto can be considered securities or commodities in order to qualify.
U.S. Securities and Exchange Commission argued that some cryptocurrency are securities. There may also be arguments for commodity classification. In some cases, it’s worth looking into. To be eligible to vote in a mark-to market election, you must first establish that the digital currency is a commodity or security. It is important to determine if one is eligible to participate in a mark-to market election by determining whether their activities are “trading” or “investing”.
The IRS lists information about traders. Traders are usually known for high volumes and short-term holding. However, investing and trading can sometimes look very similar.
If crypto is eligible for mark-to market, and you elect it if you are qualified and elect it to your securities and commodities, you can mark to trade them on the last day of the year. Any gain or loss would count as ordinary income. Gains could also be included. The benefit of this would be that it would no longer be necessary to track the date and time each crypto was purchased and identify the crypto that you sold.
This election, if it is available, will not make sense for most people. However, as with much else in crypto tax, there is much uncertainty. Some drops in crypto values have been known as a “flash fall” in the past. This is an event in the electronic securities markets in which the withdrawal of stock orders quickly amplifies the price decline and then quickly recovers. The SEC approved rules on June 10, 2010 to stop trading in stock whose prices change by more than 10% within a five-minute period.
If the stock is at a certain price, a stop-loss order directs the broker to sell the stock at the highest price. The same principle is used with crypto. You can even buy back the crypto after a sale. Stock, on the other hand, has wash sale rules that restrict selling (to trigger loss) and buying back stock in a period of 30 days. Crypto has no wash sale rules, so you can either sell or buy your crypto back immediately without waiting for a 30-day period.
This article is intended for informational purposes only and should not be construed as legal advice.
These views, thoughts, and opinions are solely the author’s and do not necessarily reflect the views or opinions of Cointelegraph.
Robert W. Wood, a tax lawyer representing clients around the world from Wood LLP in San Francisco where he serves as a managing partner. He is the author and editor of many tax books, and regularly writes about taxes for Forbes and Tax Notes.