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Losses on cryptocurrency

Last week the office of chief counsel at the IRS released a memorandum on the applicability of IRC section 165 to cryptocurrency that has declined in value. In layman's terms, what this means is that someone asked the IRS for guidance when it comes to deducting losses on cryptocurrency, and the IRS answered.


(If you want to dive right into the source document, you can view it HERE)


The Question

If a taxpayer owns cryptocurrency that has substantially declined in value, can the taxpayer deduct a loss under section 165 due to worthlessness or abandonment?


Worthlessness

Claiming worthlessness is hard to do. As

long as cryptocurrency is being traded on even one exchange, it's not truly worthless. The value may be near zero, but in many cases it is not truly worthless. This may be easier to claim for NFTs that haven't had any activity in weeks/months, but if there is any activity at all, outstanding offers, or a floor, however low, then it may not be truly worthless.


Abandonment


If you're still holding the cryptocurrency, obviously you haven't abandoned it, and you can't deduct it as a loss. In order to consider cryptocurrency abandoned, you must dispose of it by sending to a burn address. A burn address is an address that does not have a private key associated with it. For Ethereum chain assets, that address is 0x0000000000000000000000000000000000000000. Sending it to your friend, or a "burner wallet" that you have control over, doesn't count.


The Solution


So it appears claiming worthlessness is a rare case, and abandonment requires burning the asset, so how else can you capture cryptocurrency losses? If you don't want to flat out burn it, just sell it or exchange it. You can do this on any exchange that supports trading of the asset in question, but if there really is no liquidity to exchange your "near" worthless tokens, your best bet is to just burn them if you want to take the loss. Regardless of the direction you want to go, the IRS is going to look for an identifiable event in the form of a sale, exchange, or disposal. If you don't need, or want, to take the loss, you don't have to do anything, but if you plan on taking any sort of loss on your tax return, you'll need to get rid of your assets one way or another. In short, you can't have your tokens and deduct them too.

 

If you need help calculating your cryptocurrency taxes, please schedule an appointment today to get started.



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