Crypto had a tumultuous year in 2022. High volatility and a plunge in the value of major digital assets was followed by the downfall of several major cryptocurrency firms, including FTX, Celsius, BlockFi, and Voyager.
In the wake of those epic collapses, investors find themselves staring down the nose of a tax filing deadline where losses abound, funds are frozen in bankrupt firms, and the IRS is looking to regulate the crypto space more closely.
Amid the turmoil, tax practitioners say, the IRS has turned its focus to crypto investors and is seeking more information from taxpayers.
“If you have never sort of put crypto reporting on top of your mind, or front and center, I think this is the year,” said Joyce Beebe, fellow in public finance at Rice University’s Baker Institute.
Here’s what to know about cryptocurrency this tax filing season:
Filing Your 1040
US cryptocurrency holders have gotten more certainty on how to report digital assets on their Form 1040 income tax forms.
The IRS updated its 2022 form instructions in October, switching the verbiage from “virtual currency” to “digital assets,” a nod to the 2021 infrastructure bill that expanded cryptocurrency reporting requirements. The updated form explicitly says that digital assets include nonfungible tokens, or NFTs, and virtual currencies—clarifying an earlier ambiguity.
“That’s actually really significant because digital assets can include things like NFTs, which I’m not sure most taxpayers thought they had to report before,” said Sarah Paul, a partner at Eversheds Sutherland. “So that is a big change.”
In August, the IRS expanded the yes-or-no question on the income form to specify if a taxpayer received a digital assets as a “reward, award or compensation.”
The virtual currency yes-or-no question was moved to the front of Form 1040 in 2020 from the top of Schedule 1, where it was added in 2019.
There is no penalty for not checking “yes” on the 1040 form, but taxpayers who underreport their income could be subject to penalties and interest on unreported crypto.
While the clarity was welcomed by tax professionals, guidance or law is what professionals say they want most.
Claim Your Capital Losses
Over the span of about six months last year, several cryptocurrency firms went bankrupt, starting with Voyager in July and ending with FTX in November. Amid the chaos, investors saw huge swings in the value of theircoins. Prices of NFTs, many of them cartoon pictures of apes, reached dizzying heights before crashing late in the year.
Bitcoin started 2022 trading at nearly $42,000, and ended the year below $16,600. Ethereum started the year around $3,750 and ended around $1,200. FTX’s native token, FTT, plummeted in value in early November; its prospects for recovery are uncertain.
“First and foremost, if you are a crypto investor, you’re probably, say, more likely than not to have losses this year because during 2022, the value of cryptocurrency obviously decreased quite a bit,” Beebe said.
Beebe told Bloomberg Tax that frequent traders should keep track of their basis—what they paid for their coins—and harvest the losses.
“Loss harvesting” refers to a method by which investors can reduce their overall tax liability by deducting losses to offset capital gains made on other assets. Investors can deduct up to $3,000 of ordinary income on their federal taxes.
“A lot of people think that, ‘Oh, I just had losses like I don’t need to record anything,’” said Shehan Chandrasekera, head of tax strategy at CoinTracker. “Make sure you report them. It’s going to help you. It will not hurt you.”
Capital gains and losses are recorded on Form 8949, Schedule D.
Crypto Tied Up in Defunct Exchanges
Investors with assets on now-defunct exchanges face a different set of challenges than those who’ve only suffered losses.
Most investments in bankrupt exchanges are currently frozen, and will remain so until court proceedings are resolved. That means investors can’t access their coins and sell them to realize capital losses.
And in some cases, taxpayers who’ve lent assets to crypto firms such as Celsius still are required to pay tax on the interest they accrued in 2022, despite their inability to access their funds.
“Unfortunately, for the 2022 tax year, it’s tough—you cannot do anything because the transaction is not closed,” Chandrasekera said.
For now, tax professionals say, it’s best to wait and see how things play out in court because taxpayers might be able to get some of their assets’ value back.
Chandrasekera said investors should keep thorough records of all their crypto transactions so they can determine the basis.
Wash-Sales Rules
When a stock or security is sold at a loss, the wash-sales rule prevents taxpayers from buying it back within 30 days. The rule’s application to crypto remains a gray area.
The rule under Section 1091 does not currently apply to crypto. Mark DiMichael, a partner at Citrin Cooperman Advisors LLC, said he’s seen a lot of taxpayers doing wash sales.
“The wash sale rules are old rules that they made many, many years ago, and it was to prevent people from taking deductions,” DiMichael said. “But the way they wrote the rules, they didn’t write cryptocurrency as part of it, because it didn’t exist at the time.”
The House Ways and Means Committee proposed legislation in 2021 to bring digital assets under the wash-sales rules, signaling congressional interest in further regulating crypto. The proposed legislation eventually stalled.
Looking Ahead
With the infusion of $45.6 billion into the IRS for enforcement activities, tax professionals expect to see heightened scrutiny of the crypto space.
The IRS and Treasury also are working on formal rules to expand on the broker reporting requirements and anti-money laundering rule from the 2021 infrastructure law. Those rules aren’t expected to impact this filing season or the average taxpayer, tax professionals said.
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