This is Part Four in a Seven Part Series Covering Taxation of Bitcoin for US Citizens
Written by Tyson Cross a Tax Attorney based in San Diego
Part One – Tax Realization of Bitcoin Gains
Part Two – Tax Recognition of Bitcoin Gains
Part Three- Tax Character of Bitcoin Gains
Part Four – Tax Losses and Bitcoin You are Here
Part Five- Tax Deductions Related to Bitcoin
Part Six- Tax Record Keeping related to Bitcoin
Part Seven- Bitcoin Foreign Account Reporting Requirements
#20: What happens if end up with an overall loss (instead of a gain) from my bitcoins?
First, remember that gains and losses are combined at the end of the year to reach the amount of your “net gain.” If you had more losses than gains, however, then you will end up with a “net loss.” Given the two large market crashes bitcoin suffered in 2013, it’s possible that some of you will find yourself in this position. Net losses are deductible on your tax return, but there are some important limitations depending on whether they are characterized as “capital” or “ordinary” (character is discussed above).
#21: Can I deduct my net losses if they are “capital?”
Yes, but subject to a $3,000 maximum per year. This limitation is painfully low if you have substantial losses. Fortunately, any losses in excess of that amount can be carried forward and deducted in subsequent tax years (still subject to the $3,000 maximum each year). There is no limit to how long you carry your capital losses.
#22: Can I deduct my net losses if they are “ordinary?”
Yes. Ordinary losses are fully deductible and not subject to the $3,000 limitation mentioned above. If your net losses are so big that they offset all of your other taxable income, you get to carry the unused losses back two -years (by amending your prior tax returns) as a Net Operating Loss. Any remaining NOL can then be carried forward for an additional twenty years.
Keep in mind that most bitcoin holders will not have “ordinary losses.” The only time your losses will be characterized as ordinary is if (1) you are in engaged in a trade or business with bitcoins as inventory (which is possible in the case of bitcoin miners, although it is still unresolved), or (2) bitcoins are categorized as a foreign currency and your losses did not arise from a “personal transaction.”
Note: this answer ignores the possibility of passive activity or at-risk limitations, which may be applicable and need to be addressed on a case-by-case basis with a tax professional.
Continue to Part 5 — Tax Deductions related to Bitcoin