A taxpayer’s investment losses, including losses on digital assets such as cryptocurrencies and non-fungible tokens (NFTs), are not deductible unless the taxpayer’s activities rise to the level of “investment activities” or otherwise qualify as trader or dealer activities. When this is not the case, the taxpayer’s transactions are treated as nondeductible personal transactions, a hobby, or recreational activities (collectively “personal use transactions”).

Personal use transactions can involve the buying, selling, or otherwise disposing of investments. They can also include the use of digital assets to buy goods or services and the conversion of digital assets into another digital asset or a fiat currency, such as the U.S. dollar.

Tax Law Considers Intent, So Make Sure You Do Too

A taxpayer’s intent in acquiring crypto or other digital assets is important in determining whether those assets are investments or treated as personal use assets. The categorization of these assets affects tax liability.

Read More: How to Report Cryptocurrency on Your Tax Returns

A taxpayer’s intent is demonstrated by all of the facts and circumstances surrounding the transaction and the taxpayer’s other transactions for the tax year. Upon audit, the IRS can require a taxpayer to show objective evidence of investment intent. Of course, a taxpayer’s intent can change over time, but taxpayers should be prepared to demonstrate when and why intent shifted, if asked.

Tax Consequences: Gains Are Taxable but Losses Aren’t Deductible

Personal use assets are generally taxed as capital assets, with some important tax differences:

• Because of tax law changes in 2017, losses from the sale of personal use assets are not deductible.[1] Gains, however, are taxable as capital gains. In other words, personal use assets result in taxable capital gains and nondeductible losses.

• Also, as a result of the 2017 tax law changes, a taxpayer cannot deduct expenses in connection with personal use assets.

• A taxpayer’s standard capital gain rate generally applies to personal use assets, which are reported on IRS Form 8949, Sales and Other Dispositions of Capital Assets.[2]

• Personal use assets are generally subject to the standard capital gains tax rate unless they are treated as collectibles.[3] Collectibles (such as coins or artwork) are subject to a higher capital gain tax rate of 28%.[4]

• A cautionary note about certain digital assets is that some NFTs could be classified as “collectibles,” subject to the higher tax rate. IRS Notice 2023-27, issued in March 2023, states that the IRS intends to issue future guidance as to the treatment of those NFTs that should be classified as “collectibles.”[5] (for a discussion of Notice 2023-27, see IRS Takes a New Approach to NFTs and ‘Collectibles.’)

• All gains on personal use digital assets are taxable. Such assets are not treated as currency for federal tax purposes.[6] Therefore, even though Internal Revenue Code §988(e) allows individual taxpayers to exclude up to $200 of gains from personal foreign currency transactions, such a de minimis gain exemption does not apply to personal use digital assets.[7]

Keep Good Records and Reevaluate Asset Classifications

All of a taxpayer’s gains on personal use assets, including digital assets, are taxable at the same tax rates as the taxpayer’s other capital assets. These gains may also be taxed at the higher rate of 28% for collectibles if the assets are collectibles. Losses on personal use assets are not deductible.

On an ongoing basis, taxpayers should evaluate their purpose in acquiring and holding “investment assets” to determine whether those activities are investments or personal use activities.

Given the tax differences between personal use assets and investment assets, taxpayers should keep accurate records to demonstrate the nature of their activities in connection with the acquisition and disposition of various assets.[8]

[1] IRS, Topic No. 409 Capital Gains and Losses, last updated Sept. 21, 2017.

[2] IRS.gov/instructions/i8948

[3] Code §408(m)

[4] Topic No. 409

[5] Notice 2023-27, https://www.irs.gov/pub/irs-drop/n-23-27.pdf

[6] Notice 2014-21, 2014-16 I.R.B. 938

[7] Notice 2023-34, https://www.irs.gov/pub/irs-drop/n-23-34.pdf

[8] See IRS Small Business and Self-Employed Tax Center.

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