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Rex Hamlett, CPA
June 22, 2022

Crypto Losses & the Bear Market

With bears dominating the market trend so far for 2022, fear, uncertainty, and doubt have ruled. Due to the recent DeFi wide volatility in price action, we have witnessed the collapse of UST & LUNA on the Terra ecosystem, and a month later possible insolvency for another major crypto protocol, Celsius, as well as crypto venture capital firm Three Arrows Capital facing possible liquidation. The pain of this market crash is casting a wide net over DeFi as a whole, leaving many of us wondering how to deal with our ill-begotten losses. Hopefully this article will bring some insight during this uncertain time.

Crypto Currency

Many of you may be in the following scenarios; 1) Holding stable-coins (UST) and tokens in underwater positions, 2) sold or swapped stable-coins (UST) for a loss, 3) were liquidated on leveraged positions, 4) or lost some or all of your net worth from the UST/LUNA crash. Let’s  unpack each situation independently to discuss the tax implications, and bring clarity on how to  move forward.

1) Whether you’re holding stable-coins and/or tokens at spot, have them staked, or are invested in liquidity pools, your losses are “unrealized” until those positions are disposed of, or swapped. Once disposed of or swapped, the losses are “realized” capital losses. Realized capital losses can be used to offset realized capital gains for 2022.

a. If you have no realized capital gains for 2022, realized capital losses are deductible up to $3,000 for the year, and any unused amount is carried forward to subsequent years.

b. If you have unrealized losses, an option would be to wait for the dust to settle, and then dispose of your holdings in an amount that makes sense for your tax situation.

2) If you disposed of stable-coins (UST) at a loss, this is treated differently than the US dollar. Stable-coins are a separate asset class, and losses can be realized as stated above. Realized capital gains and losses should be reported on a transaction-by-transaction basis using IRS Form 8949 – Sales and Other Dispositions of Capital Assets.

Note: moving crypto between wallets does not create a taxable event, and transaction fees also do not create taxable events. However, transaction fees should be added to the basis of the crypto they are related to, as this will help offset any capital gains that could be realized at the time of disposition.

3) If you held collateral on a protocol, such as Anchor Protocol, and your collateral was liquidated, it is a realized capital loss.

a. Note that the amount you borrowed/leveraged from your collateral is not considered taxable income.

4) If you were one of those unfortunate enough to have lost everything during the UST/LUNA collapse, know that our hearts go out to you. If you were staking, or invested in a liquidity pool, you’ll report “other income” for the staking and liquidity pool rewards you received, and capital losses for any sales, swaps, or liquidations that occurred.

The tax rules surrounding crypto are multi-faceted and complex. We are here to help, and hope that you find value in this post during these tumultuous times.

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