What should people do who have lost money as a result of losses on cryptocurrencies and the like? The author takes a look at tax loss harvesting.

As readers know, the bankruptcy of Bahamas-registered cryptocurrency exchange FTX late last year capped what had been a poor year for much of the space, given the earlier meltdown for some "stablecoins" and the fall in bitcoin prices – in lockstep with the slide in Big Tech more broadly. When dramas like this take place, it shakes confidence in the underlying promise of the technologies. (This news service is not going to take a view on the specific legal charges against those involved in FTX, because this is a live legal matter.) 

But, as the dotcom boom and bust showed, out of the rubble can be found plenty of genuinely useful business models, products and services. A century ago, there were hundreds of automobile firms in the US. Now there is just GM, Ford and Stellantis (formerly Chrysler). It is not clear, therefore, that the case for holding digital assets and entities such as distributed ledger technology has gone away. An era of ultra-low/negative official interest rates created speculative froth and unwise risk-taking. As rates go up, and hopefully more normal macroeconomic conditions apply, some of the nonsense might be swept to the sidelines, leaving more room for serious players to operate. (See here for an article looking at digital assets and wealth management.) In any event, this new service is pleased to share these comments from regular contributor Matthew Erskine, managing partner of his law firm, Erskine & Erskine. The usual editorial disclaimers apply to views of guest writers. Jump into the conversation. Email tom.burroughes@wealthbriefing.com

FTX filing for bankruptcy joins the line of failed cryptocurrencies and their platforms in 2022. Even such market dominant cryptocurrencies as bitcoin and Ethereum have lost an impressive amount of value this year. Many people and organizations are now holding cryptocurrencies which are either worthless or are worth only a small fraction of what they were purchased for. Some of these cryptocurrencies may recover their value but it may take years. Others may not or you cannot wait that long. Is there anything you can do?  Yes, there is and it is called tax loss harvesting. 

The tax code allows investors to offset realized capital gains against realized capital losses and, if you do not have enough realized capital gains to offset the realized capital losses this year, you can take up to $3,000 against your ordinary income as a deduction, then carry the losses forward on your tax return and use them as an offset for future realized capital gains. 

To qualify for this tax harvesting you must meet the proper conditions. First, the cryptocurrency must be held in a taxable investment account, not in an IRA or other Qualified Deferred Compensation account. Second, you must actually sell the cryptocurrency. Some cryptocurrencies still have a small value, and some platforms will, for a fee, buy the cryptocurrency from you for zero value. Next, you must have actually realized capital gains in 2022, or after if you carry the losses forward. Finally, you need to correctly report the loss to the IRS. 

You report losses on cryptocurrency on Form 8949 “Sales and other Dispositions of Capital Assets.” To complete form 8949 you will need the name of the cryptocurrency, the date you purchased it, the cost basis (usually the purchase price), the date you sold it, the sale price and the net gain or loss on the transaction. It is likely that the exchange or broker involved in the sale will issue you a 1099 in early 2023 with some of this information on it. Once you have done so, you will need to transfer that information to Schedule D of your income tax return.  

So, you can take advantage of your losses, however painful, if you can find capital assets that have appreciated and you can sell. Keep in mind, however, that if you die holding cryptocurrency or any other capital assets that show a loss, you will lose that loss since the asset will receive a new, stepped up, cost basis as of the date of your death.