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Deductibles and Reducing Capital Gains
There are several approaches to reducing tax liabilities, here we summarize some of the more common strategies. In any event, we recommend you speak with a tax attorney or accountant to develop whatever strategies are best for your personal investment and tax situation.
You can deduct your capital losses against capital gains. This applies to all types of capital gains, so you can use them against any property, not just cryptocurrency. You must always offset your losses against your capital gain first, but if your losses are higher, then you can also use those remaining against your income up to $3,000 per year. Your capital losses can also be carried over to the following tax year.
If your portfolio has made large gains during the tax year but decreased in value, then you could apply a tax loss harvesting strategy to realize your losses before the year-end to offset your gains.
If you have purchased cryptocurrency that has since fallen in value, then you can strategically sell it to realize your losses and then buy back straight away to offset your gains. There is a rule called the Wash Sale Rule to prevent this from happening for stocks and shares however, since the IRS sees cryptocurrency as property, and does not separate it from stocks and shares, cryptocurrency holders can utilize this strategy under current law.
There are some incidental costs of purchase and disposal that can be deducted from capital gains. There is not much IRS guidance on what is acceptable, so the best practice is to assume that if the cost relates to the acquisition and disposal of cryptocurrencies, then it is allowable. Therefore, while cryptocurrency trading fees are likely deductible, transfer fees do not follow this same rule.
For mining expenses, different rules apply depending on if the miner idenfities as a hobbyist or business miner.
Hobbyists can claim certain expenses on Schedule A (Itemized Deductions), which can reduce their tax liability. Hobbyists can deduct ordinary and necessary expenses connected with the hobby. Ordinary expenses are those that are common and accepted for the activity, while necessary expenses are those that are appropriate for it.
Deductions should be itemized on the tax return. If the expenses are higher than the mining income, then there is a loss. But this cannot be deducted from other income.
Business miners can deduct the expenses allowed to hobbyists as well as additional business expenses. These should be reported on Schedule C. If the business operates at a loss, they may be able to use their losses to offset other income.
Business miners should consult a tax attorney or accountant to determine which business deductions will be applicable for their situation.
Under the Tax Cuts and Jobs Act passed in 2017, losses as a result of stolen cryptocurrency are not deductible unless attributable to a federally declared disaster. Prior to the Tax Cuts and Jobs Act, a victim may be able to claim a casualty loss and a deduction on Schedule A if they can prove they did hold the cryptocurrency at some point and yet there is no chance of recovering the cryptocurrency.
However, it could be argued that the hacked/stolen crypto is now “worthless” and therefore sold as $0. As a result, you would record a capital loss in the amount of the original cost basis.