What the Terra Luna Collapse Means for Your Crypto Taxes
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Capital losses on UST or LUNA may be used to offset income and capital gains. Capital losses may be carried forward to future years.
Depending on your crypto tax accountant's advice, you may be able to write off LUNA as a worthless security.
It’s not been a good week for crypto traders as a whole, but it’s been a horrendous week for holders of algorithmic stablecoin Terra (UST) and its sister coin LUNA. With the market at two-year lows and many UST or LUNA holders struggling to sell their worthless or near-worthless assets, many are wondering if and how they can realize crypto losses on their taxes.
In this blog, we’ll discuss several common scenarios that traders are facing, how each one may affect crypto taxes, and both Luna tax and Terra tax consequences in light of the situation.
Selling Luna or Terra tax consequences
If you were able to sell UST or LUNA before it lost all value, you should report the sales as capital losses on your income taxes. You can use them to offset up to $3,000 of ordinary income and can offset an unlimited amount of capital gains. Capital losses are reported on Form 8949 and Schedule D.
Additionally, you will be able to carry forward losses. So, even if you had an overall capital loss in 2022 and can’t use losses to offset gains, you will be able to carry forward those losses to future years in which you have overall gains. Losses can be carried forward indefinitely.
In a given tax year, the amount of losses you can carry forward is the amount of your total net loss that is more than your allowable capital loss deduction for the year or your taxable income increased by your allowable capital loss deduction for the year. IRS Worksheet 4-1 can help you determine this amount.
Worthless Luna tax consequences
If you weren’t able to sell your LUNA before it lost its value, your position is trickier. Typically, you have to be able to sell or swap crypto in order to realize a loss so you can claim it on your taxes. If there’s no market for your assets, this can be difficult or impossible.
The IRS allows tax deductions for worthless securities that are considered capital assets. While cryptocurrencies are often capital assets, the SEC has not officially ruled that they are securities. However, a 2017 decision concerning The DAO’s governance tokens and recent comments by SEC Chair Gary Gensler could suggest that in the future, some digital assets may be classified as securities.
Taking this into consideration, there may be an avenue for deducting worthless LUNA from your income taxes. At the time of writing, LUNA is trading at $.0001 (5/16/22) and might be considered worthless—depending on your crypto tax accountant’s guidance. Note: you must report the loss in the year the asset became worthless.
Because UST is trading for $.10 (5/16/22), it cannot yet be considered a worthless asset, but this may change in the days ahead.
To claim a worthless security on your taxes, you have to formally abandon it (relinquishing all rights to it) and/or provide documentation that it has no value, such as a letter from the company saying it has ceased operations.
26 CFR § 1.165-5 of the IRS tax code says the following:
(i) Abandonment of securities -
(1) In general. For purposes of section 165 and this section, a security that becomes wholly worthless includes a security described in paragraph (a) of this section that is abandoned and otherwise satisfies the requirements for a deductible loss under section 165. If the abandoned security is a capital asset and is not described in section 165(g)(3) and paragraph (d) of this section (concerning worthless securities of certain affiliated corporations), the resulting loss is treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset. See section 165(g)(1) and paragraph (c) of this section. To abandon a security, a taxpayer must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for the security. For purposes of this section, all the facts and circumstances determine whether the transaction is properly characterized as an abandonment or other type of transaction, such as an actual sale or exchange, contribution to capital, dividend, or gift.
We recommend working with a crypto tax accountant to determine how to best fulfill these requirements.
If you didn't hold Terra or Luna but have losses
Even if you didn’t hold UST or LUNA, you’ve likely had sizable losses in your crypto portfolio. This might be a good time to consider crypto tax loss harvesting. This is a strategy in which assets are sold at a loss in order to lower one’s amount of taxable capital gains.
If you don't have liquid assets to pay your 2021 taxes
If you're insolvent after the Terra Luna crash and don't think you will be able to pay your 2021 taxes, the IRS provides payment plan options. Note that if you apply for an IRS payment plan, you will need to provide them with full transparency to your finances, as well as pay any associated plan fees.
Frequently asked questions about the Terra Luna collapse
Here are answers to frequently asked questions about the Terra Luna collapse and the corresponding tax consequences.
How do I report Luna losses on my taxes?
US taxpayers can report capital losses on their income taxes. You can use these losses to offset ordinary income and capital gains, with the ability to carry forward losses to future years. Luna losses are no different.
Can I claim crypto losses on taxes?
You can typically claim crypto losses on taxes. If you experienced losses due to the Terra Luna crash or other crypto holdings, you may be able to report these crypto losses on your tax return. The process involves documenting sales, calculating capital losses, and using them to offset gains or income. A crypto tax professional will be able to assist and provide clarity.
How does Luna affect tax?
The effect of Luna on taxes depends on whether you sold it before it lost all value or if it became worthless. If you sold Luna, report the sales as capital losses. If your Luna became worthless, you may be able to deduct it as a loss on your taxes.
Do I have to report crypto on taxes if I didn't sell?
Reporting crypto on taxes is required even if you didn't sell. Crypto transactions, including trades, conversions, or receiving crypto as income, trigger tax implications. Failure to report these activities can lead to non-compliance. If Luna became worthless and you want to claim a loss, you may need to formally abandon it, following specific IRS guidelines. Consult with a crypto tax professional for accurate guidance.
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Last reviewed by Zac McClure,MBA on November 29, 2023 · Sources