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All About Cryptocurrency Tax Loss Harvesting

This article about Cryptocurrency Tax Loss Harvesting explains:

  • what is tax loss harvesting
  • how you can use this method to reduce your cryptocurrency tax liability

One of the most effective ways to reduce your tax bill for the year is to engage in tax loss harvesting with your cryptocurrency assets. It’s common knowledge that cryptocurrencies are incredibly volatile. Realizing your tax loss and other characteristics make it a useful candidate for tax loss harvesting strategies.

What is Tax Loss Harvesting?

Tax Loss Harvesting is the practice of selling a capital asset at a loss to offset a capital gains tax liability. By realizing or “harvesting” a loss, investors can offset taxes on both gains and income. This is a tax reduction strategy often used in the world of stocks and securities.

Let’s look at a general example:

Beth buys $1,000 of Microsoft stock and $2,000 of Apple stock in a given year. While holding these investments, the value of her Microsoft stock rises to $1,500, while Apple drops to $1,700. She sells all of his Microsoft stock for $1,500.

Without Tax Loss Harvesting

Without harvesting her losses in Microsoft stock, Beth has a $500 capital gain for the year from the sale of her Microsoft stock. She pays taxes on all $500 of this capital gain.

With Tax Loss Harvesting

Rather than continuing to hold her Apple stock, Beth can harvest her losses in Apple by selling before the year-end. Capital gains and losses get added together for the year resulting in either a net gain or loss. Her net capital gain is now only $200 for the year ($500 – $300). In this scenario, Beth only pays taxes on $200 of net capital gains rather than $500.

All About Cryptocurrency Tax Loss Harvesting

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Cryptocurrencies are always treated as property for tax purposes, the same as traditional stocks. This means that you can strategically sell or trade crypto to harvest losses and reduce your tax liability. However, unlike stocks, cryptocurrencies have unique characteristics that make them even better candidates for tax loss harvesting.

Wash Sale Rules
  •  A wash sale results when you sustain a capital loss and then repurchase the same security within 30-days. This is before or after the capital loss is incurred. It was designed to prevent investors from taking capital losses in one year and then immediately buying back the stock. The IRS states that the wash sale rules apply only to securities. It was deemed that Cryptocurrencies are property, and not securities, as defined by the IRS guidance. This means that currently, the wash sales rules do not apply to cryptocurrency.
  • Cryptocurrencies are very volatile, more so than traditional assets. This volatility means that investors have extensive opportunities to realize and harvest capital losses. The problematic part for investors is identifying which of the cryptocurrencies (in their portfolios) have the highest cost basis (original purchase price) when they are compared to the current market price. These are the assets that present the most significant opportunity for tax savings.

Let’s look at another example:

Alan has made $15,000 in capital gains from investing in the stock market this year. He has also been investing in cryptocurrencies like Bitcoin, XRP, and Ethereum. In December, he notices that his investments are down over $20,000 for the year. To harvest these losses, Alan trades all of his cryptocurrencies into Litecoin.  Thus incurring a taxable event and realizing his losses. Alan’s losses in cryptocurrency completely offset all of his stock market gains, and he then will have a capital loss for the year of $5000.

Net Capital Losses Up to $3,000 Offset Ordinary Income

  • When total capital gains and losses for the year add up to a loss, a net capital loss is then incurred.
  • If the net capital loss is less than or equal to $3,000 ($1,500 if you are married and filing a separate tax return), then that entire capital loss can be used to offset other types of income – such as the job-related income.
  • Net losses exceeding $3,000 are rolled forward to subsequent years.

Sell or Trade Once Detected

  • Once you determine which cryptocurrencies present the best tax savings opportunities, you can then sell or trade them on your exchange of choice. You must understand that selling or trading your crypto will trigger a taxable event and “realize” your losses in the asset. December 31st is the deadline.

The tax year ends on Dec. 31st, even though the filing deadline isn’t until April 15th. This means that you must realize your losses before the end of the year if you want them to impact that year’s taxes.

Many investors delay only to discover that they could have saved money on their tax bill if they would have sold or taken their losses in December. And by then it’s too late.