- within Tax topic(s)
- with Senior Company Executives, HR and Finance and Tax Executives
- in United States
- with readers working within the Accounting & Consultancy industries
U.S. cryptocurrency tax law continues to evolve unevenly, particularly where taxpayers seek to deduct significant digital asset losses as ordinary losses rather than capital losses. Unlike Canada, where courts have recently addressed cryptocurrency loss characterization directly, the United States has not yet produced a single, definitive judicial counterpart. Instead, U.S. taxpayers must rely on long-standing tax principles that distinguish between investment activity and a trade or business.
Under current IRS guidance, cryptocurrency and other digital assets are treated as property for U.S. federal income tax purposes. As a result, losses arising from cryptocurrency transactions are generally capital losses unless the taxpayer can establish that their digital asset activity rises to the level of a trade or business. This distinction is critical. Capital losses are subject to strict limitations, while ordinary losses may, in appropriate circumstances, offset other sources of income.
The IRS has historically taken a conservative view of cryptocurrency loss characterization, often resisting attempts by taxpayers to claim ordinary loss treatment. This posture has taken on greater significance as market volatility, exchange collapses, and fraud have resulted in substantial unrecovered digital asset losses.
The U.S. Legal Framework for Business-Level Cryptocurrency Activity
U.S. tax law does not contain crypto-specific rules for determining whether a taxpayer is engaged in a trade or business. Instead, courts apply general principles developed across decades of tax jurisprudence. One of the most frequently cited authorities is Commissioner v. Groetzinger, in which the Supreme Court articulated that a trade or business requires activity conducted with continuity, regularity, and a primary purpose of income or profit.
These principles now play an increasingly important role in U.S. cryptocurrency tax disputes. Factors commonly examined include the frequency of transactions, the amount of time devoted to trading or management, the presence of systems or operational structure, and the taxpayer's intent. Where digital asset activity resembles organized, profit-seeking commercial conduct rather than passive investment, taxpayers may attempt to characterize losses as ordinary.
Experienced and knowledgeable U.S. tax lawyers caution, however, that satisfying this standard is difficult. The IRS frequently challenges assertions that cryptocurrency trading constitutes a business, particularly where activity is conducted individually rather than through a formal entity or infrastructure.
Exchange Failures, Fraud, and Digital Asset Losses in the United States
The collapse of centralized cryptocurrency exchanges and the emergence of fraud-related losses have intensified scrutiny of digital asset loss deductions. From the IRS's perspective, the mere fact that a loss arises from misconduct, insolvency, or platform failure does not automatically convert a capital loss into an ordinary loss.
Depending on the facts, taxpayers may explore several possible characterizations, including capital loss treatment, theft loss claims, or business loss treatment. Each category has distinct legal requirements, evidentiary thresholds, and timing rules. In practice, the IRS applies these doctrines narrowly, and taxpayers asserting ordinary loss treatment must be prepared to substantiate their position rigorously.
For this reason, experienced U.S. tax lawyers often emphasize proactive planning, contemporaneous documentation, and early assessment of loss characterization before positions are taken on a return.
Practical Implications for U.S. Cryptocurrency Investors and Traders
For U.S. cryptocurrency investors, traders, and entrepreneurs, the capital versus ordinary loss distinction has material consequences. Capital losses are generally limited to offsetting capital gains, with only modest relief available against ordinary income. By contrast, ordinary losses arising from a crypto trading business may offset other income streams, subject to IRS review.
This distinction has become increasingly relevant as sophisticated traders engage in high-volume activity, algorithmic trading, and structured crypto strategies. Where losses occur, the ability to demonstrate business-like conduct may determine whether meaningful tax relief is available.
Frequently Asked Questions on U.S. Cryptocurrency Tax Losses
Can U.S. cryptocurrency losses ever be treated as ordinary losses?
Yes, but only in limited circumstances. Ordinary loss treatment generally requires that the taxpayer's cryptocurrency activity qualify as a trade or business under established U.S. tax principles. The IRS closely scrutinizes such claims, and most cryptocurrency losses continue to be treated as capital losses.
Does the IRS treat exchange collapses or fraud differently from market losses?
Not automatically. Exchange failures or fraud do not, by themselves, establish ordinary loss treatment. The characterization depends on the surrounding facts, including the nature of the taxpayer's activity and the legal basis for the claimed deduction.
What evidence is most important in supporting business-level treatment?
Transaction frequency, time commitment, operational structure, profit motive, and contemporaneous records are central. Unsupported assertions of business intent are rarely sufficient.
Additional Considerations for DeFi and NFTs Under U.S. Digital Asset Tax Rules
As digital asset markets expand beyond traditional cryptocurrency trading, taxpayers increasingly face losses connected to decentralized finance platforms and non-fungible tokens. While these technologies introduce new economic mechanics, U.S. tax law generally applies the same analytical framework across all digital assets.
For U.S. tax purposes, cryptocurrencies, DeFi tokens, and NFTs are typically treated as property. Accordingly, the same capital loss versus ordinary loss analysis applies, regardless of the specific digital asset involved. Experienced and knowledgeable U.S. tax lawyers emphasize that technological novelty does not, by itself, alter tax characterization.
DeFi and NFT FAQs
Is this analysis relevant for DeFi, NFTs, or newer digital assets?
Yes. Although many IRS discussions focus on cryptocurrency such as Bitcoin or Ethereum, the legal framework applies broadly to digital assets, including DeFi tokens and NFTs.
Where trading or operational activity is frequent, organized, and profit-driven, taxpayers may attempt to argue trade or business treatment, though the IRS continues to scrutinize such positions closely.
How are losses from DeFi liquidity pools, staking, or protocol failures treated under U.S. tax law?
Losses from DeFi liquidity pools, staking arrangements, smart contract exploits, or protocol failures do not automatically qualify as ordinary losses. In many cases, the IRS may view these losses as capital losses associated with the disposition or worthlessness of a digital asset interest.
Ordinary loss treatment generally depends on whether the taxpayer's DeFi activity constitutes an ongoing business supported by continuity, regularity, and profit motive.
Are NFT creators and NFT traders treated differently for U.S. tax purposes?
Yes. NFT creators may generate ordinary income when minting and selling NFTs, particularly where the activity resembles a commercial enterprise.
NFT traders who acquire NFTs for resale or appreciation are more commonly treated as investors, with gains and losses characterized as capital.
Where NFT trading is frequent and systematic, business treatment may be argued, but the IRS evaluates each case based on substance rather than form.
Pro Tax Tips for U.S. Cryptocurrency, DeFi, and NFT Participants
- Maintain detailed records of cryptocurrency, DeFi, and NFT transactions, including time devoted and trading patterns
- Evaluate loss characterization before filing, particularly where losses are substantial
- Treat DeFi protocol participation and staking as high-risk from a tax characterization standpoint
- Clearly distinguish NFT creation activity from NFT trading activity
- Consult experienced and knowledgeable U.S. tax lawyers early when digital asset losses arise
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
