No Tax Deduction Allowed on Worthless Cryptocurrency While Held

A loss in a cryptocurrency cannot be claimed as a deduction for tax purposes solely because the asset declined to the point of having almost no value.

In a private memo, the Internal Revenue Service (IRS) explained that the rationale rests on Section 165 of the Internal Revenue Code. It allows a deduction for losses that are closed and completed transactions, marked by identifiable events and sustained during the taxable year. Basically, when an individual sells a security for a loss during a taxable year, they can claim a deduction on the loss.

Section 165(g) allows any security that is a capital asset and becomes worthless during the taxable year to be treated as a loss when sold or exchanged. A security is defined as: a share of stock; a right to subscribe for, or to receive, a share of stock; or a bond, debenture, note or certificate, or other indebtedness, issued by a corporation or a government or political subdivision.

When a taxpayer still holds an asset that depreciates—in this case, a cryptocurrency—they have not abandoned or otherwise disposed of the asset. Additionally, the memo stated that if the cryptocurrency continued to be traded on at least one exchange, the cryptocurrency cannot be deemed worthless because it still has potential future value.

The example from the memo best explains the situation. The taxpayer is an individual who purchased units of a cryptocurrency in 2022 at $1.00 per unit. On December 31, 2022, the cryptocurrency depreciated to under $0.01 per share but was still traded on at least one exchange and the taxpayer maintained control of the cryptocurrency. Therefore, the taxpayer cannot claim a deduction under Section 165 since the loss is not evidenced by a closed and completed transaction and the security could not be determined to be entirely worthless. Even though the cryptocurrency had substantially decreased in value, its value was greater than zero and it had the potential to increase in value and be traded in the future.

Source: “Applicability of I.R.C. section 165 to cryptocurrency that has declined in value,” by Ronald J. Goldstein; Internal Revenue Service, January 2023.