Used your Bitcoin on a new Lambo? TV? - Bitcoin Personal Tax Loss Limitations

On January 1, 2018, the professional magazine, Journal of Accountancy, released an important article discussing the documentation of virtual currency transactions. I wanted to take this opportunity to address a little covered topic on cryptocurrency tax losses, the personal loss limitations.

General

By now, you may be aware that Bitcoin and altcoins are treated as property for U.S. tax purposes. This means, if they are sold (or exchanged) at a gain, a U.S. taxpayer is subject to income tax on the gain. As long as the asset is held as a capital asset, the gain is a capital gain (subject to lower rates if held for more than one year).

With losses, it gets more tricky. If a virtual currency is sold at a loss, here are many limitations that can dictate how the loss is deducted. Factors include:

• Was the virtual currency a capital asset?
• Does taxpayer have capital gains to offset the loss? (In the U.S., an individual's capital loss deduction is limited to $3,000 per year if it exceeds other capital gains).
• Was the virtual currency an investment or for personal use?
• Is the loss derived from a decline in the value on an actual sale or exchange? For most taxpayers, only realized losses would be permitted
• Is the loss derived from theft or destruction of the property?
• The virtual currency a SEC-designated security subject to wash sale rules if bought back shortly after the sale?

Loss of Personal Use Funds

But one thing that is not commonly discussed is the potential to have a nondeductible capital loss. This can occur when a virtual currency wallet is used primarily for personal use. And is discussed in the following article.

Source: https://www.journalofaccountancy.com/issues/2018/jan/documenting-virtual-currency-transactions.html

The Journal of Accountancy is a professional magazine written by accountants for accountants. Trusting in the valuable information provided in the Journal of Accountancy is infinitely more reliable than typical media sources (especially social media sources).

According to the Journal of Accountancy's author, although virtual currency is held with a profit motive, the use of the currency could be the deciding factor in whether the currency is an investment, or is for-personal-use property. Generally, using a crypto wallet for personal transactions could taint the character of the wallet, if the value of crypto declines in value. This is consistent with my understanding of tax guidance, the tax law often can function to tax/accelerate gains, and limit/preclude losses.

What is my personal wallet is hacked, can I deduct a loss?

In the U.S. individuals can deduct losses related to a transaction intended to be for profit, or a trade/business. Otherwise, losses are not permitted (sec 165(c)). However, there is a limited exception for destruction/theft. Please note that the there are significant loss limitations on the destruction/theft of personal use property that come into play before any tax benefit can be realized. I did briefly touch on this issue in theft loss article published on September 26, 2017.

...However, if the wallet was primarily used for personal transactions unrelated to investing (i.e. purchases from Microsoft Store or Overstock, etc.), the IRS may treat this as an Unrelated Loss, subject to the $100/10% floors...

https://steemit.com/money/@cryptotax/was-your-bitcoin-stolen-potential-tax-benefits-for-your-loss

Takeway

• To preserve the investment nature of Bitcoin/altcoin holdings, it is advisable to maintain a separate wallet for personal-use transactions.
• Or, another option is to do as the Journal of Accountancy's author recommended, instead of using virtual currency for personal transactions, sell virtual currency at a loss and use the cash to pay for personal transactions.

Otherwise, co-mingling investment and personal funds could quickly become messy business.

Professional Resources:

https://www.journalofaccountancy.com/issues/2017/nov/trading-virtual-currencies-coinbase-bitcoin.html
https://www.journalofaccountancy.com/issues/2018/jan/documenting-virtual-currency-transactions.html

Picture Credit
https://pixabay.com/en/office-two-people-business-team-1209640/

Disclaimer: This series contains general discussion of U.S. taxes in a developing and unclear area of tax law. As always, you should consult your own tax advisor in your jurisdiction to determine your specific situation as this is not personal advice; and consider any future guidance by the Congress/IRS after the date of this article. Under Circular 230 to the extent it applies, this article cannot be used or relied on to avoid any tax or penalties in the U.S., its States or any other jurisdictions. This post/book does not create a client relationship between the author and the reader.