How to Use Crypto and NFT Losses to Cut Your Tax Bill

As we emerge from crypto winter, many investors are sitting on losses from both crypto and NFT investments. Crypto tax calculator, Koinly, explains how there might be a silver lining when it comes to your tax bill.

Following a harsh winter for crypto, where the market suffered an estimated loss of $2 trillion from its 2022 all-time highs, investors are beginning to see a flicker of hope. But if you’re sitting on losses from the previous financial year, you’re not the only one.

However, there may be a silver lining in terms of your tax liabilities. We’ve partnered with crypto tax calculator, Koinly, to break it down for you.

Capital gains vs. capital losses

First things first, let's talk about capital gains and losses.

It's important to note that crypto tax rules can differ depending on where you live, so make sure to check the specific regulations in your area. Koinly has got you covered with more than 20 guides on crypto tax from all around the world. But in this guide, we’ll be focusing on the US capital gains and losses rules.

In the US, crypto is viewed as an asset, similar to property or stocks. Whenever you dispose of your crypto by selling, swapping, or spending it, you will realize a capital gain or loss.

Capital gains are taxable, but the good news is that you can offset capital losses against gains to reduce your tax bill. Better still, you can even get strategic with your losses to optimize your tax bill by following three simple steps.

Track, harvest & offset losses

There are three steps to strategically using losses to minimize your tax liability:

Track unrealized losses
Harvest losses
Offset your losses

1. Track unrealized losses

If you're looking to get a better understanding of how your portfolio is performing, it's essential to track both the good and the bad.

But don't worry, you don't need to pour through dozens of spreadsheets to do this. Just use a crypto portfolio tracker like Koinly to keep tabs on your overall performance and the performance of individual assets. Koinly can track unrealized gains and losses. This helps you know when it’s time to take your profits or cut your losses.

Once you’ve spotted an unrealized loss, you need to harvest it.

2. Harvest losses

Unrealized losses are worthless from a tax perspective. In order to make the most of them, you need to dispose of your asset and realize the loss - also known as harvesting a loss.

You can realize a loss by selling, swapping, or spending your crypto. Outside the US, some countries also count gifting crypto as a disposal.

Of course, some losses are easier to realize than others. There are some common loss scenarios many investors may find themselves in - for example, with rug-pulled tokens, illiquid NFTs, frozen funds, or losses from theft. Here’s how you may be able to deal with these to realize your loss:

Rug-pulled tokens: Rug-pulled tokens leave you with a worthless investment, but until you dispose of them, they count as an unrealized loss. How you dispose of them will depend on the liquidity of the market. If you can sell your tokens, even if it's for almost nothing, that's your best bet. If you can't sell them, try swapping them using a non-custodial wallet. Even if you get another practically worthless token, it will still help you realize your loss. If neither option is possible, sending your rug-pulled tokens to a burn address is another way to dispose of them.
Illiquid NFTs: Got some illiquid NFTs weighing down your portfolio? Don't worry - they can still be a great opportunity for tax loss harvesting. All you need to do is dispose of them. Selling or swapping them, if your market isn’t entirely illiquid, is the easiest way to do this, even if you’re selling for a negligible amount. If the market is entirely illiquid, realize your loss by sending your NFT to your blockchain's burn address.
Funds frozen in crypto exchanges: If you're one of the many investors with your funds frozen on collapsed crypto exchanges like FTX, Celsius, or Voyager, sadly, there's not much you can do to realize your loss right now. Your best bet is to wait for the bankruptcy proceedings to wrap up. Don’t lose hope though, many investors are starting to make claims as part of the bankruptcy proceedings from exchanges that collapsed last year and may soon see at least some of their funds returned.
Losses from theft: It’s more bad news for US investors. The IRS says theft is not a capital loss unless it’s related to a federal disaster. Unfortunately, you will not be able to claim a capital loss due to theft.

3. Offset losses

With your losses realized, you now need to offset them - and there are some particular rules you need to know about:

There is no limit to the number of losses you can offset against gains.
No gains to offset against this year? You can carry losses forward to future financial years.
The IRS allows taxpayers to offset an additional $3,000 in losses against ordinary income each year.
There is a wash sale rule in the US. This rule exists to stop investors from selling assets at a loss and buying them back in a short period of time, effectively creating an artificial loss to use for tax purposes. However, this rule does not yet apply to crypto, only stocks. You can learn more in Koinly’s crypto tax loss harvesting guide.

Reduce your tax bill with Koinly

Our partner, Koinly, helps you track, harvest, and realize your losses. In even better news, Koinly helps you calculate your crypto tax liability and generate a range of reports for tax offices around the world - including the IRS Form 8949 & Schedule D, TurboTax Reports, and more.

Get an exclusive 30% discount on Koinly crypto tax reports when you sign up to Koinly using code RARE30.

Disclosure

The information on this website is for general information only. It should not be taken as constituting professional advice from Koinly. Koinly is not a financial adviser or registered tax agent. You should consider seeking independent legal, financial, taxation or other advice to check how the website information relates to your unique circumstances. Koinly is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly, by use of this website.

How to Use Crypto and NFT Losses to Cut Your Tax Bill