Quick overview

Cryptocurrency losses occur when you dispose of a digital asset for less than your adjusted basis (what you paid plus fees). For most individual investors, those losses are capital losses reported on Form 8949 and Schedule D (Form 1040). In other circumstances—chiefly when crypto trading is a bona fide trade or business, or when a rare tax election is allowed—losses can be ordinary. The distinction matters because capital losses generally offset capital gains first and only up to $3,000 ($1,500 if married filing separately) of net capital loss may offset ordinary income each year; excess carries forward indefinitely (subject to future tax law changes) (IRS: Treatment of Virtual Currency; Form 8949 instructions).

Why classification matters for your tax bill

  • Capital loss treatment: Losses offset capital gains dollar-for-dollar. If your net capital loss exceeds capital gains for the year, individual taxpayers can deduct up to $3,000 of the excess against ordinary income ($1,500 if MFS). Any remaining net capital loss carries forward to later years. (See IRS Schedule D and Form 8949 instructions.)
  • Ordinary loss treatment: Ordinary losses can offset ordinary income without the $3,000 cap and often reduce self-employment or business taxable income in the year they occur. Ordinary loss treatment may be available if crypto activity rises to the level of a trade or business or if other specific tax authorities apply.

In my practice, clients who treat crypto as a hobby or long-term investment almost always report capital losses. Traders who show consistent, businesslike trading, rely on it for income, and meet trader-tax-status criteria sometimes obtain ordinary-loss treatment—though the IRS scrutinizes these claims.

IRS treatment: crypto as property (the baseline rule)

The IRS treats virtual currency as property for federal tax purposes (IRS Notice 2014-21; IRS virtual currency pages). That baseline means general property tax rules for gains and losses apply: basis, holding period, capital vs ordinary distinctions, and reporting on Form 8949/Schedule D.

Authoritative resources:

Capital loss: when it applies and how to report it

When you sell, exchange (including crypto-to-crypto trades), gift, or otherwise dispose of crypto held as a capital asset, you realize a capital gain or loss. Key points:

  • Calculation: Realized loss = Amount realized (sale proceeds) minus adjusted basis (cost plus fees). Example: Bought BTC for $10,000 (basis) and sold for $7,000 (proceeds) → $3,000 capital loss.
  • Holding period: If held one year or less, it’s short-term (taxed like ordinary income for gains). Over one year = long-term (preferential rates for gains). The holding period affects only the character of gains; losses follow the capital loss rules for offset and carryover.
  • Reporting: List transactions on Form 8949, then carry totals to Schedule D (Form 1040). Keep clear records to support basis and dates.

Practical tip: If you actively move coins between wallets or exchanges, preserve timestamps and transaction IDs. Fees, network costs, staking rewards, and airdrops can affect basis—document them.

Ordinary loss: when it might apply

Ordinary loss treatment for crypto is uncommon for casual investors but possible in narrow situations:

  • Trader tax status: If you qualify as a trader in securities/commodities under IRS rules, you may elect mark-to-market (MTM) accounting under section 475(f) to treat gains and losses as ordinary. However, the MTM election traditionally applies to securities and commodities; the applicability to crypto remains unsettled and fact-specific. If the IRS accepts MTM for your activity, losses are ordinary.
  • Business loss: If crypto activity is part of a business (e.g., operating a crypto brokerage, running a mining business that sells production regularly), losses may be ordinary business losses subject to regular business loss rules and limitations.
  • Theft/casualty: Certain losses from theft or qualified casualty might be treated differently; consult current law for disaster/forgiveness rules.

Caution: The IRS closely examines claims of trader status or MTM for crypto. Achieving ordinary-loss treatment typically requires: high frequency of trades, a businesslike manner, intent to profit from short-term market swings, and substantial time spent trading. Documentation and professional tax advice are essential.

Wash-sale rule and crypto (current status and cautions)

The wash-sale rule (IRC §1091) disallows losses on sales of stocks or securities if you repurchase ‘substantially identical’ securities within 30 days. As of 2025, the wash-sale rule applies to stocks and securities; it has not been explicitly extended by statute or clear IRS rule to virtual currency, which the IRS treats as property. That said, lawmakers have proposed changes in the past, and tax authorities could update guidance. Do not assume wash-sale protection for crypto indefinitely—track updates and ask a tax professional whether recent rule changes affect you (IRS virtual currency guidance).

Specific identification vs. FIFO

You can use specific identification to choose which units you sold if you can reliably identify them (transaction IDs, wallet records, timestamps). If you cannot, many platforms default to FIFO (first in, first out). Specific ID can materially change tax results when prices vary widely across lots; keep precise records to use it.

Practical examples

1) Investor sale (capital loss): You bought 1 ETH at $3,000 and later sold it for $1,500. Result: $1,500 capital loss. Use Form 8949 to report; offset gains or up to $3,000 of ordinary income; carry forward remainder.

2) Frequent trader claiming ordinary loss: A full-time trader executes thousands of trades, uses margin, reports trading as a business, and timely files an MTM election accepted by the IRS for similar activity. Losses treated as ordinary could offset ordinary income—this is uncommon and high audit risk.

3) Crypto-to-crypto trade: Trading BTC for ETH is a taxable disposition of BTC—calculate gain/loss using the fair market value of ETH received. Losses from that sale are capital unless other rules apply.

Recordkeeping checklist (what to keep and why)

  • Purchase date and cost basis (price + fees)
  • Sale/exchange date and proceeds (USD value at the time)
  • Transaction IDs, wallet addresses, and exchange statements
  • Receipts for mining expenses, staking, or fees that affect basis
  • Exported CSVs from exchanges and blockchain records when needed
  • Documentation supporting specific-identification claims
    Good records make it possible to prove your tax position if the IRS asks.

Tax planning strategies (practical, compliant)

  • Tax-loss harvesting: Realize losses to offset gains, but be mindful of market timing and long-term investment goals.
  • Use specific identification when possible to choose higher-basis lots to sell.
  • Track positions across wallets and exchanges to avoid unexpected taxable events (token swaps, airdrops, hard forks).
  • If you trade at scale, discuss trader tax status and the mark-to-market election with an experienced crypto tax advisor before filing.

Common mistakes to avoid

  • Forgetting that crypto-to-crypto trades are taxable dispositions.
  • Failing to include exchange fees and gas costs when calculating basis.
  • Assuming wash-sale rules never apply without monitoring legislative changes.
  • Relying on exchange reports alone—many platforms underreport or misclassify transactions.

Where to report and forms to know

  • Form 8949: Sales and other dispositions of capital assets—list each transaction with basis and proceeds.
  • Schedule D (Form 1040): Summarize capital gain/loss totals.
  • If you claim trader/MTM treatment or business losses, different forms and elections may apply—work with a tax professional.

For further reading on capital loss mechanics and planning, see our guides on Capital Loss and Cryptocurrency Tax Reporting: Gains, Losses, and Compliance.

Takeaway and disclaimer

Most crypto losses are capital losses for individual investors—use them to offset gains and deduct up to $3,000 against ordinary income each year, with the remainder carried forward. Ordinary-loss treatment is limited, fact-specific, and often requires special status or elections. Tax rules for virtual currency continue to evolve; stay current.

Professional disclaimer: This article is educational and not tax advice. For individualized guidance about your crypto activity and possible elections (trader status, MTM), consult a qualified tax professional or CPA familiar with virtual currency and current IRS guidance.