Did your cryptocurrency holdings lose in value this year? To optimize your US tax burden, you could realize those losses and use them to offset other capital gains. You can then buy crypto again at the current market rate. This is called tax loss harvesting and can be applied to crypto holdings.
This tax optimization strategy can have significant benefits, even for future years, when done right.
What is Crypto Tax Loss Harvesting?
The crypto tax-loss harvesting strategy involves selling crypto that you currently hold at a loss, meaning you bought it at a higher price than it is today, and immediately repurchasing it.
Selling it will result in a capital loss that can then be used to offset capital gains from investments, stocks, or other crypto sales.
Even if you don’t anticipate any capital gains this year, there are still benefits to the tax-loss harvesting strategy. Capital losses can also be used to offset ordinary income up to $3,000 per year ($1,500 if you are single or married filing separately). Any unused losses are then carried forward to future years.
Does The Wash Sale Rule Apply To Crypto?
Investors that use tax loss harvesting strategies are familiar with the Wash Sale Rule. A Wash Sale generally occurs when within 30 days before or after selling or trading securities at a loss, you buy substantially identical securities.Â
The US implemented the Wash Sale Rule to prevent investors from selling stocks and securities just to realize losses, and immediately buying back the same or almost same securities.
Luckily for crypto investors, the Wash Sale Rule explicitly only applies to securities. The IRS considers cryptocurrency a property and not a security. Thus, the Wash Sale Rule does not currently apply to crypto investments.
This may change in the future. The US government is aware of this tax loophole and has made attempts to close it.
Deadline For Harvesting Crypto Losses
The deadline for realizing cryptocurrency losses is December 31st. You will need to sell your crypto at a loss within the calendar year if you want to harvest those losses in your next year’s tax return.
Due to the high volatility of digital assets and the fact that the Wash Sale Rule does not apply to crypto, selling and rebuying works very well for cryptocurrency investments.
Crypto Tax Loss Harvesting Risks
Every time you sell an asset and buy it back later, the holding period resets. If the holding period is less than one year, short-term capital gains tax rates (10-37%) apply. When holding it for more than one year before selling it, then you will pay long-term capital gains taxes (0-20%).
So, harvesting crypto losses every year can keep you in the short-term holding period with a higher tax rate. Should the market go up and you sell at a gain, you’d pay the higher short-term capital gains tax on the gain.
Tracking crypto transactions can be tedious. To avoid missing out on any potential savings, we recommend consulting with an experienced crypto tax accountant.
Who Can Benefit from Crypto Tax Loss Harvesting?
Crypto tax-loss harvesting primarily helps investors in higher tax brackets and with significant capital gains. Investors with lower incomes only pay little to no long-term capital gains tax and wouldn’t benefit as much.
The long-term capital gains tax of 0% applies in these situations:
- Single or married filing separately and your taxable income is below $44,625,
- Married filing jointly and your taxable income is below $89,250 or
- Head of Household and your taxable income is below $59,750.
If your taxable income exceeds those thresholds, harvesting crypto losses may make sense for you.
Crypto Tax Loss Harvesting Example
Assume you invested $8,000 in Bitcoin (BTC). The position is currently worth $3,000. You still want to own BTC, so selling it now makes little sense.
However, you can sell your BTC to effectively capture a $5,000 capital loss and immediately buy it back because the Wash Sale Rule does not apply to crypto transactions.
Then you can use the $5,000 realized loss to offset any capital gains or deduct from income up to $3,000 in value. Any unused losses can be carried forward into future tax years.
Reporting Taxable Transactions
Navigating the reporting of crypto taxable events can present various challenges:
First and foremost, accurately determining the cost basis of cryptocurrency holdings is crucial for calculating capital gains or losses. The array of methods available, such as FIFO (First In, First Out), can be quite perplexing.
Additionally, solely relying on Forms 1099 generated by centralized exchanges is not enough. They tend to be incomplete, potentially leading to complications with the IRS.
Furthermore, many cryptocurrency investors have a high volume of transactions, making it a real challenge to meticulously track each one.
Lastly, the regulatory landscape for crypto assets is still evolving. Staying up to date can be challenging for individuals aiming to accurately report gains or losses.
Crypto Tax Planning
Incorporating tax loss harvesting can be valuable for your overall cryptocurrency strategy to efficiently manage tax liabilities. This legal strategy enables the offsetting of other capital gains if aligned with IRS regulations.
At Online Taxman, our specialized team remains current with the latest IRS guidelines, ensuring a smooth navigation of crypto taxation for our clients. Schedule a consultation with us to alleviate any concerns about inaccuracies in your tax returns.
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