Tax Treatment of Bitcoin Losses
This post deals only with “capital losses.” If your bitcoin losses are characterized as “ordinary losses,” then these rules wouldn’t apply. However, very, very few people will have “ordinary losses” from bitcoin. Unless you qualify as a “day trader” (which is not easy to do) and have elected to use the mark to market method for determining your gains/losses, it’s very likely that your bitcoin losses are “capital losses.” If you’re unsure, talk to a tax professional to determine whether your losses are ordinary or capital.
Do capital losses offset capital gains?
Yes. We’ll get more into the mechanics of calculating gains and losses below, but for now all that matters is that capital gains are determined on a net basis. This means that all your gains and losses for the year are added against each other to reach either a “net gain” or a “net loss.” So, yes, losses do offset gains.
Example: Bob owns three bitcoins and sells all of them in 2014. He had a gain of $600 on coin #1, a gain of $400 on coin #2, and a loss of ($900) on coin #3. Bob has a net gain of $100 for the year.
What about long-term vs. short-term? Do these apply to losses also?
Yes. This is where the mechanics of the calculation start to come into play. Remember that when calculating gain or loss, all gains and losses are sorted into either “short-term” or “long-term” depending on whether the underlying bitcoin was held for more than one year. So, this means that there are actually four categories of gains and losses: (1) short-term gains, (2) short-term losses, (3) long-term gains, and (4) long-term losses.
The short-term gains and short-term losses are added together to reach a net short-term gain or a net short-term loss.
The long-term gains and long-term losses are also added together to reach a net long-term gain or a net long-term loss.
Finally, the long-term and short-term gain/loss are added together to reach one final number: your “net capital gain or loss.”
So what does that even mean? Can long-term losses be used to offset short-term gains? Or visa-versa?
Yes. The above calculation boils down to one important point: If you end up with a net loss in one category, that loss will carryover and offset your gains in the other category. So, yes, long-term losses can be used to offset short-term gains.
Keep in mind that this is all handled by your tax preparation software, so if your head is spinning a little bit, don’t worry about it. All you need to remember is that losses offset gains of the same character first, and then any excess will carryover to offset gains of the other character second.
Example: Bob sold 2 bitcoins in 2014 that he’s owned for 2 years. He had a gain of $1,000 on this sale. Bob also sold 3 bitcoins that he’s owned for 13 months. He had a loss of ($1,500) on this sale. Finally, Bob sold 1 bitcoin that he’s owned for 9 months. He had a gain $750 on this sale.
Bob has a long-term loss of ($500). Bob has a short-term gain of $750. * *Bob will report a net capital gain of $250 on his tax return (characterized as short-term).
note: For the sake of simplicity, I’m going to purposely disregard the short-term/long-term distinction for the rest of this post since it has very little impact on the issue of losses and would unnecessarily complicate the examples.
Can bitcoin losses offset gains from other types of assets?
Yes. Bitcoins are a capital asset (except in a few limited circumstances), and therefore gains and losses from bitcoins are mixed together with the gains and losses from other capital assets.
Example: Bob sold 2 bitcoins in 2014 for a total loss of ($1,000.) Bob also sold shares of stock in Apple Corporation for a gain of $600 and shares of stock in Netflix for a gain of $400.
Bob has zero capital gains in 2014. Note: Bob still needs to include a Schedule D with his tax return, which will show these transactions and the calculation of his $0 net capital gain.
What happens if my losses exceed my gains?
If you had more losses than gains during the taxable year, then the above calculation will result in a “net capital loss.” A net capital loss is reported on your tax return as a negative number.
However, there is a ($3,000) limitation on capital losses. No matter how big your capital loss ends up being, you can only use $3,000 of it on your tax return.
Example: Bob decided that he made a bad investment in bitcoins and decided to cash out entirely. He sells all of his bitcoins for a loss of ($12,000) at the end of the year. Bob also sold some shares of stock for a $2,000 gain earlier in the year.
When Bob calculates his capital gains for the year, he ends up with a ($10,000) net capital loss for the year. However, he can only take ($3,000) of the loss on his tax return. The remaining ($7,000) of losses are put on hold and again carried forward to future years.
What do I do with carried losses in the future? Can I use them to offset future gains?
Yes. Any losses in excess of the $3,000 limitation are carried forward and included in the net gain calculation in future years. There is no limit to how long you carry your capital losses.
*Example: Bob has ($7,000) of carried losses from 2013. In 2014, Bob sold shares of stock for a gain of $7,000. *
Bob will include his carried losses of ($7,000) in the calculation of his net capital gain for 2014. So, Bob has zero capital gains for 2014. Remember: bitcoins are a capital asset, and therefore gains/losses are combined with other capital assets like shares of stock.
Suppose instead that Bob had carried losses of ($15,000) from last year. When Bob’s carried losses are included in the calculation of his net capital gains, he’ll end up with a capital loss of ($8,000). Bob can report ($3,000) of this loss on his tax return, and the remaining ($5,000) becomes a carried loss and will be carried forward once again.
Can I carry losses backwards to earlier tax years?
Unfortunately, the answer is no. Capital losses can only be carried forward. So, for example, losses realized in 2014 from the price collapse in bitcoin cannot be used to offset gains in 2013 (when bitcoin hit all-time highs).