U.S. cryptocurrency tax law continues to evolve unevenly, and taxpayers often seek to treat digital asset losses as ordinary rather than capital losses. Unlike Canada, the United States has not yet produced a single, definitive judicial counterpart, so courts rely on long-standing principles that distinguish investment activity from 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. The Groetzinger framework requires activity conducted with continuity, regularity, and a primary purpose of income or profit, and 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. From the IRS’s perspective, losses arising from misconduct, insolvency, or platform failure do not automatically convert a capital loss into an ordinary loss, and the collapse of centralized exchanges and fraud-related losses have intensified scrutiny. The IRS applies these doctrines narrowly, and taxpayers asserting ordinary loss treatment must substantiate their position rigorously.
For U.S. cryptocurrency investors and traders, 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 becomes more relevant with high-volume trading, algorithmic strategies, and DeFi/NFT activity, where the line between investment and business is tested and may depend on conduct rather than labels. Where losses occur, the ability to demonstrate business-like conduct may determine whether meaningful tax relief is available. For U.S. cryptocurrency investors, traders, and entrepreneurs, the capital versus ordinary loss distinction has material consequences: capital losses offset gains, while ordinary losses from a genuine trading business may offset other income, subject to IRS review. This distinction becomes more relevant with high-volume trading, algorithmic strategies, and DeFi/NFT activity, where the line between investment and business is tested and may depend on conduct rather than labels. Practical tips include maintaining contemporaneous records, evaluating loss characterization before filing, treating DeFi participation and staking as high-risk, clearly distinguishing NFT creation from NFT trading, and consulting experienced tax counsel early when losses arise.
Leave a Reply