Happy New $YEAR: How To Deduct Crypto Losses On Your 2021 Tax Return

• Published date: 27 January 2022
• Subject Matter: Tax, Technology, Income Tax, Tax Authorities, Fin Tech
• Law Firm: Freeman Law
• Author: Mr Fernando Juarez

2021 was an incredible year for crypto investors. Tokens such as Polygon ($MATIC), Sandbox ($SAND), Decentraland ($MANA) had incredible gains, with investors realizing returns in excess of 100% of their original investment. Yet, investors may be looking at a hefty tax bill for 2021, if they failed to plan accordingly.

Crypto investors were not the only category of persons to proser. 2021 was also a great year.for crypto-scams. Epic failures such as Squid Game ($SQUID) literally wiped millions of dollars, generating substantial losses to thousands of investors. Launched on October 26, SQUID went from a $0.01 to a peak of $2,862 in a week, before falling to $0.00 after the developers performed what is commonly known as a "rug pull" (meaning that the developers abandon the project by selling their tokens and taking the investors' money - hence "pulling the rug out" under the investors' money). In these cases, the investors holding the tokens sustain giant losses without further possibility of recovery.

One of these "rug pulls" was performed on the last day of 2021-in less than 6 hours. The $YEAR token was launched as a "year in review" of the user Ethereum transaction history. The scam prohibited the investors from selling because the token developer activated certain code - embedded within the token software - preventing the investors from selling their tokens and only allowing purchases. This caused the price to soar to 0.0009 ETH only to drop to 0.000118 ETH and then zero after the rug pull.

Investors should exercise caution and be aware of such scams in order to prevent monetary losses-but also to prevent unintended tax consequences, such as the limitations on deducting losses.

The Internal Revenue Code (IRC) provides two primary avenues to deduct losses. Section 162 allows taxpayers to deduct ordinary and necessary expenses incurred in carrying on a trade or business. I.R.C. ' 162. Another provision that allows individuals to deduct losses is Section 165, which allows taxpayers to deduct losses sustained during the year and not compensated by insurance. I.R.C. 165(a).

The first question to properly determine the tax treatment of a loss in cases such as $SQUID and $YEAR, is to determine whether an individual is engaged in a trade or business. If "yes," the individual may be able to deduct the loss incurred in his business. If not, the taxpayer must resort to Section 165 to deduct the loss. A recent tax case, Antonyan, et. al. v. Comm'r, T.C. Memo....