It's hard to read about developments in the cryptocurrency space without seeing articles about token thefts, post-initial coin offering declines in value and market volatility. These are recurring themes reported on in our Blockchain Monitor blog posts. According to a recent survey, U.S. investors who have sold bitcoin collectively have realized approximately $1.7 billion in losses, but only 53 percent plan to report bitcoin gains and losses on their tax returns.

Like most commercial events, tax planning presents ways to provide value, reduce risk and/or enhance operating efficiency for crypto market participants. Proper tax planning can yield positive results and should be considered by investors with significant crypto market activity. Favorable tax treatment can be achieved by addressing the fact that crypto assets are capital assets for market participants that are not dealers. That means that gains and losses are not "ordinary" from a tax perspective, which in turn means that any net capital losses of an individual taxpayer can be carried forward to provide for a $3,000 annual deduction only until the carryforward is used up (assuming there are no capital gains in that or proceeding years).

There are many strategies to minimize inefficiencies related to the characterization of gains and losses as capital verses ordinary. Some of these include:

  • Disposing of crypto assets in a way that creates an ordinary deduction rather than a capital loss.
  • Holding crypto assets in certain entities where character is less relevant and gains and losses offset each other without regard to character.
  • Planning to achieve dealer status where crypto assets are treated as ordinary in nature.

Depending on a taxpayer's investment strategy, there may be a trade-off between long-term capital gains tax rates and tax rates for ordinary income. However, those rates will not apply when a crypto asset is held for less than one year. Moreover, avoiding inefficiencies of mountains of capital loss carryforwards could militate in favor of employing a strategy that is not reliant on a long-term holding period.

Separately, other considerations might exist when crypto assets are held by a domestic corporation. This is because capital losses can be carried back for three years, providing refunds of prior taxes paid on capital gains. In addition, corporations can carry capital losses forward for only five years, after which they vanish (whereas individuals can carry forward their capital losses indefinitely). Thus, corporations might have more pressure to pursue strategies that avoid capital losses.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.