Capital Carryover Losses and the Limit on the Deduction of Carryover Losses

You can carryover capital losses forward each year. $3k worth of losses can be deducted from capital income or ordinary income each year until the full amount is deducted.

It works like this:

In the first year where capital losses are realized, capital losses can only be deducted from capital gains up to the amount gained. The rest can then be carried over indefinitely.

Thus, if you for example gain $20k and lose $40k, you have a $0 taxable capital gain and $20k capital loss to carryover into future years.

However, in each subsequent year only $3k can be deducted (the limit is the same for an individual or family).

As a bonus though, in these subsequent years capital losses can be deducted from both capital and ordinary income (so if you have a wage, but you don’t make capital income, you can still utilize losses from past years).

See IRS Topic Number 409 – Capital Gains and Losses. Click here to learn more about cryptocurrency and taxes.

Understanding Capital Losses and the Carryover Rules in Crypto Trading

The above can be very important to understand in crypto trade due to how volatile it can be!

If you lose a bunch of money in crypto this year, you can thankfully deduct those losses over the course of years moving forward (potentially upping your assistance and reducing your tax liability).

That said, the news isn’t all good. You can still fall into some brutal tax traps with crypto. Let me give an example:

  • Joe invested $1k in 2017.
  • He turned it into $30k in 2017 and realized $29k in gains in 2017.
  • He then lost $20k in 2018 and realized $20k in losses in 2018.
  • He then gets back to $30k in 2019 and realizes $20k in gains in 2019.
  • He then decides to HODL and not trade, and thus has no capital gains in 2020.

Joe would owe taxes on $29k worth of capital gains in 2017 ($1k to $30k), then he would have losses of $20k in 2018 ($30k to $10k), but then owe $17k worth of taxes for 2019 ($10k back to $30k is $20k gains minus $3k of losses carried over from 2017). Joe would then have $17k worth of deductions to carry forward, getting to deduct $3k of that each year. So in 2020 he deducts $3k from his ordinary income, and then has $14k to carry over into 2021. Etc.

So, in this example Joe paid taxes twice. Once on his first ride up to $30k in 2017, and once on his second ride up in 2019. Meanwhile, Joe’s losses, since they were in another tax year, had those carry over rules applied.

The end result is Joe paid taxes on $59k worth of gains over a three year period, and gets to take $20k worth of losses over the course of years. Not bad, but a strange way to make money, and not what the average person imagines when they think about those mythic crypto gains.

Conclusion

In sum, you can fall into some tax traps with crypto trading due to the volatility, but that doesn’t mean taking heavy losses in a year has no benefit.

Capital gains and losses are always calculated in a year, and you always owe taxes on your net capital gains. However,  you can carry net losses forward. The first year you can take capital losses against gains up to the amount gained, but then moving forward you can take them against either ordinary or capital income at a rate of $3k a year.

Given the above, it is important to consider how gains and losses work before realizing gains by trading crypto-to-crypto or cashing out into fiat… especially if plan on reentering the market!

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