While losing money never feels good, especially in flash crashes and other macro market events in crypto, there is a bright side - significant tax savings.
Luna lost billions of dollars in value in the span of a few days, leaving nearly all of its investors holding digital assets that were close to worthless in comparison with their previous value. If you lost money on Luna or Terra, let's walk through how to turn these losses into tax savings on your IRS tax bill.
First, let's talk through just what happened to Luna.
Understanding the collapse of Luna/Terra
In May of 2022, the Terra stablecoin lost its peg with the US dollar. For unfamiliar investors to crypto, Stablecoins are digital assets which have their value tied to a set value. This allows access to digital assets without the volatility seen in some currencies. However, in the case of Terra, the peg to the set value was lost, eroding trust in its underlying ability to be "stable" causing it to crash further. Terra was something known as an algorithmic stablecoin, which is a concept where there exists a stablecoin and a connected cryptocurrency that backs up the stablecoins value. In the case of Terra, this was Luna.
In theory, algorithmic stablecoins can work, but like we've seen in the case of the Terra/Luna collapse, they can also be incredibly risky. The best way to think of it is this:
The algorithm can keep the stablecoin stable within a certain set of operating market conditions. Let's call this the expected range. In normal market conditions where the protocol and ecosystem maintain the continued trust and support of users, the algorithm does its job. However, when unstable market conditions and lack of trust arise – among a variety of other factors – this can slowly push the operation of the stablecoin and its partner cryptocurrency outside of the expected range, or outside of normal operation conditions, increasing the probability that the algorithm can collapse, destroying the value of both.
So, with all of this said, can you write off your losses if you did in fact lose money on Luna or Terra? Probably.
What can you do if you sold your coins?
If you sold your coins, known as a disposal of the asset, you can claim this as either a capital gain or loss on your tax return. In the case of Luna and Terra, chances are if you're reading this article you'll be able to claim it as a capital loss.
Capital losses can be used to offset any gains you incurred throughout the year from trading other cryptocurrencies or traditional assets like stocks or bonds. In addition to this, IRS regulations allow you to offset up to 3000 of income for the year as well. If you lost more money than that in a single year, you luckily can carry your losses into future tax years to offset additional years' gains.
In scenarios like this, you can actually transform what is an otherwise terrible financial situation, into one that can be beneficial come tax time and one that's helpful as you make more gains on trading activities in the future.
What can you do if you didn't sell your coins?
If you didn't sell your Terra or Luna assets, this is known as unrealized losses and as such, the IRS doesn't actually count this as a loss. Chances are if you're still holding your coins, you're likely hoping that the coins regain their value in the future. While we can't predict what will happen, if you the value does end up going up in price down the line and you end up making a profit on Luna or Terra, you'll eventually have to claim this as a capital gain after you sell.
But, it's important to note your time horizon for investing, as there are other tax saving strategies you might want to consider. For one, you can use tax-loss harvesting to book the present unrealized loss of your cryptocurrency holdings in your current tax year, then buy back into the asset at a later date to bank on future gains. This strategy helps you realize the loss for tax purposes and then potentially still make gains on the asset when it rises in the future.
How do I figure out how to claim my losses?
In the world of cryptocurrency, if you're an active trader you probably have some complicated and seemingly endless transaction and purchase history. However, the IRS doesn't care how complicated your trading history is, if you want to claim the loss, or pay taxes on any gains, you're going to have to break everything down for them. Before you start selecting any number of choice words you may have for the IRS upon realizing this, there is hope.
The Ledgible crypto tax and accounting platform automates the process and spits everything out for you in one easy to handle spreadsheet, form (like an 8949), or integrates directly to your personal tax software or your CPAs professional tax software.
Ledgible works by using read-only keys to aggregate transaction and currency data. Then, through the use of our on-chain nodes, the platform is quickly able to calculate gain/loss data, establishing cost basiseven on complicated assets that have been transferred through any number of wallets and exchanges.
Ledgible is free to try and use throughout the year for tax purposes, users and tax professionals will only be charged when they pull reports come tax-filing time. You can learn more and get started here.