New rules and enforcement actions are coming to ferret out crypto transactions that often went unreported in the past. There’s a bit of good news as well: This year’s painful selloff brings an opportunity for crypto holders to harvest losses to offset future taxes. 

Here’s more to help investors make smart crypto moves in the next few weeks—and get ready for new IRS scrutiny.  

Crypto losses as a tax-saving tool

There’s a silver lining for investors whose crypto holdings are in taxable accounts rather than tax sheltered accounts such as IRAs.   

The benefit is that if an investor sells this crypto and books a capital loss, it can be used to offset future capital gains on winners. These gains don’t have to be on digital assets; they could be on stocks, real estate, or other investments.

If an investor with capital losses has no capital gains to shelter, the losses can offset up to $3,000 of ordinary income such as wages per tax return, per year. These losses don’t expire.  

Say that John has a $20,000 loss in his crypto holdings now. If he sells and has no capital gains to offset, he can reduce his wage income by $3,000 this year and in future years. If he then has a capital gain of $5,000 two years from now, he won’t owe tax on it—and he’ll still have $9,000 to offset future taxes. 

In a key way, crypto losses have an advantage over stock losses. If an investor sells shares at a loss, the “wash-sale” rules penalize him if he also buys the same stock within 30 days before or after the sale.  

But the wash-sale rules don’t currently apply to cryptocurrencies. So crypto investors can have their cake and eat it too, by taking losses now to shelter future gains and then repurchasing favorites right away. There’s no need to wait and risk missing a market surge—if there is one. 

New IRS reporting by brokers

The 2021 Infrastructure Investment and Jobs Act included a provision requiring crypto brokers to report customers’ sale proceeds to the IRS on a 1099 form, if it’s held in a taxable account. The requirements are akin to what brokerage firms report for investors’ stock sales.

The change aims to clamp down on many crypto investors’ cavalier—and sometimes criminal—tax avoidance. Until Congress acted, few crypto transactions had to be reported to the IRS by third parties such as exchanges, and many investors have ignored crypto tax rules. In a recent court filing, the IRS said that in 2019 only about 100,000 tax returns reported crypto transactions. That’s far less than would be expected given research showing that about 20% of American adults have bought, traded, or used cryptocurrencies.   

The new law is set to take effect Jan. 1, 2023, so the first forms would go to taxpayers and the IRS in early 2024. However, tax specialists say the date may be postponed because the Treasury Department hasn’t issued regulations detailing the laws defining thorny issues such as who is a crypto broker. Crypto firms also need to update software.  

The new rules will likely increase complexity, even for crypto investors complying with the law—so it could make sense to accelerate moves into this year. More paperwork will likely lead to more errors by taxpayers and the IRS that take time to untangle, says Shehan Chandrasekera, head of tax strategy at CoinTracker, a provider of crypto tax-filing software.   

For crypto holders who aren’t compliant, he adds, “The new reporting doesn’t change the taxation of cryptocurrencies. But it will tell the IRS about your transactions—so it’s important to put things in order now.”    

 New court-ordered searches for crypto tax cheats 

In August and September federal judges approved two new summonses requiring a crypto exchange and a bank to turn over customer information to the IRS to uncover tax cheating using cryptocurrency.

The crypto exchange is sFox, a crypto prime dealer with more than 175,000 customers whose transactions have totaled more than $12 billion since 2015, according to a Justice Department statement. The bank is M.Y. Safra Bank, which had an agreement to provide banking services to sFox customers. Neither business is accused of wrongdoing.

sFox and M.Y. Safra must turn over to the IRS account information on sFox customers who had $20,000 or more in crypto transactions in any one year from Jan. 1, 2016 to Dec. 31, 2021. 

To justify the summonses, the agency provided examples of 10 unnamed people who didn’t declare taxable income from transactions conducted largely through sFox. The unreported income ranged from $1 million by someone allegedly involved in a Ponzi scheme to $5,000 by someone whose return showed wages, retirement income, and Social Security payments—but no crypto profits. 

The IRS has already used this strategy, called a John Doe summons, to pursue crypto tax cheats with transactions of $20,000 or more at three other exchanges:

Coinbase,

Kraken and Circle. From these and other efforts, the agency has assessed more than $110 million in tax due on unreported crypto income, with more expected. Penalties and interest could nearly double the total that some taxpayers owe. 

Future summonses are likely, says Don Fort, a former chief of IRS criminal investigations now with the Kostelanetz law firm: “The IRS and Justice Department have become adept at tailoring requests judges will approve.”  

The IRS’s dogged pursuit of past cases is a reminder to investors with unreported crypto income that it may not stay hidden—and the consequences could be severe. 

Write to Laura Saunders at Laura.Saunders@wsj.com

Corrections & Amplifications
Taxpayers who have no taxable capital gains can deduct up to $3,000 of capital losses against ordinary income such as wages. An earlier version of the story incorrectly said the deduction would reduce income tax, not income. (Corrected on Nov. 11)