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Wednesday, February 28, 2024

Tax law researchers propose IRS framework for deducting crypto losses

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Researchers at Indiana University and the University of Maine recently published a study examining the current state of cryptocurrency tax law in the United States. The research concludes with recommendations for the Internal Revenue Service (IRS) that, if adopted, would prevent taxpayers from weighing crypto losses against other capital gains.

The paper, dubbed simply “Crypto Losses,” seeks to define the various forms of loss that can be accrued by businesses and individuals invested in cryptocurrency and proposes a “new tax framework.”

Current IRS guidelines concerning cryptocurrency are somewhat nebulous. For the most part, as the researchers point out, cryptocurrency losses tend to follow the same taxation rules as other capital assets. They’re typically deductible against capital gains (but not other gains such as income), but there are some distinctions as to when and in what amounts deductions may occur.

Related: New tax rules could mean a US exodus for crypto companies

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Cryptocurrency losses that accrue from specific cases defined as “sale” or “exchange,” for example, would be subject to deduction limitations. However, in other situations, such as having crypto stolen or instances where holders abandon their assets (through burning or other destructive means), taxpayers could deduct the losses in their entirety.

This is based on the information provided in IRS publication 551, as cited in topic 409:

“Almost everything you own and use for personal or investment purposes is a capital asset. Examples include a home, personal-use items like household furnishings, and stocks or bonds held as investments.”

According to the researchers, cryptocurrency losses should be regulated differently than other capital assets. The initial claim made in their research is that “the government is essentially sharing in the risk created by the investors’ activities” by offering a deductible against capital gains.

Their argument concludes that a new tax framework should be built wherein cryptocurrency losses may only be deducted from cryptocurrency gains.

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According to the researchers, “losses from one type of activity should not be used to offset or shelter income from another activity.” Essentially, this suggests that cryptocurrency should be disenfranchised from other capital gains deductions.

However, the researchers acknowledge that other capital losses are not given similar treatment, stating that, currently, a “loss from the sale or exchange of any capital asset can offset gain from the sale or exchange of any other capital asset.”

As to why cryptocurrency losses shouldn’t be given the same taxation consideration, the authors state that by sharing risks with cryptocurrency investors in offering loss deductions on capital gains, the government may be stifling the economy and harming the cryptocurrency market:

“This risk-sharing can encourage investment in cryptocurrency and away from other investment activities of valuable economic significance. Risk sharing can also encourage investors to suddenly exit the crypto industry, which can harm legitimate exchanges and remaining investors.”

Despite the apparently subjective conclusion, the authors acknowledge that preventing taxpayers from applying cryptocurrency losses to other capital gains could harm investors who, under the status quo, would otherwise be entitled to the same taxation relief and recovery as those suffering similar asset losses unrelated to cryptocurrency.