If the price of your cryptocurrency has plummeted, there may be a silver lining that can save you thousands of dollars on your tax bill: tax-loss harvesting.
In this guide, we’ll break down what tax loss harvesting is, explain why cryptocurrency is an unusually effective candidate for taking advantage of it, and walk through a step-by-step process to help you identify the best candidates for tax savings in your crypto portfolio.
If you sell your stocks, real estate assets, or cryptocurrencies at a profit, you’ll be required to pay capital gains tax based on how much money you’ve made from the sale.
Some investors choose to reduce their capital gains in a given tax year by selling some of their assets at a loss. This is called tax-loss harvesting.
Tax-loss harvesting is a very common strategy in the world of stocks and securities. To get a better understanding of how it works, let’s look at an example.
Here’s how much John incurs in capital gains if he decides not to take advantage of tax-loss harvesting.
Here’s how much John incurs in capital gains if he realizes his losses on his Tesla stock.
Just like stocks, cryptocurrencies can be used for tax-loss harvesting. This means that you can also strategically sell/trade crypto to harvest losses and reduce your tax liability.
Unlike stocks however, cryptocurrencies have unique characteristics that make them even better candidates for tax-loss harvesting. Let’s go through some of these advantages.
Right now, the IRS has a ‘wash rule’ in place that’s designed to prevent investors from taking capital losses and then immediately buying back the same stock. Incurring a capital loss on a stock is not allowed if you buy the same security 30 days before or after the sale.
The IRS specifically states that wash sale rules only apply to securities. Cryptocurrencies are property, not securities, as defined by IRS guidance. This means that as of now, wash sales rules do not apply to cryptocurrencies—however, this could change in the future.
Cryptocurrencies are extremely volatile—more so than traditional assets. This volatility means that crypto investors have more opportunities to realize and harvest capital losses.
The difficult part for investors is identifying which of the cryptocurrencies in their portfolio have the highest cost basis (original purchase price) when compared to the current market price. These are the assets that present the greatest opportunity for tax savings.
At the end of this article, we’ll share a step-by-step strategy for identifying tax-loss harvesting opportunities. Before jumping into that, let’s share a few tips for investors looking to harvest their capital losses.
Whenever total capital gains and losses for the year add up to a negative number, a net capital loss is 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—like the income from your job.
Net losses exceeding $3,000 are rolled forward to subsequent years.
Many investors choose to wait until the end of the tax year to identify tax-loss harvesting opportunities and minimize their capital gains.
This strategy is not ideal.
Because cryptocurrencies are so volatile, investors often have multiple opportunities to take advantage of tax-loss harvesting over the course of a year. Regularly taking advantage of these price dips can help investors save money and reduce stress at the end of a tax year.
If you find yourself in one of these scenarios, tax-loss harvesting may not be right for you.
Consider the following question in the infographic below.
The answer to the infographic above depends on what accounting method Brian chooses to use for his crypto transactions. In the United States, investors typically use the first-in first-out (FIFO) accounting method to calculate their crypto gains and losses. This accounting method sells off your coins in the order you received them.
Other accounting methods such as last-in first-out (LIFO) or highest-in first-out (HIFO) also exist. These methods require investors to be able to specifically identify the cryptocurrency that they’re selling.
To learn more about how each of these accounting methods works, check out our complete guide to FIFO, HIFO, and LIFO.
If you’re using multiple wallets and exchanges, it can be difficult to keep track of the cost basis for each one of your assets. That means it can be difficult to identify tax-loss harvesting opportunities.
CryptoTrader.Tax can help. The platform allows you to find all your tax-loss harvesting opportunities in minutes.
Let’s walk through the process.
Once you know which cryptocurrencies present the best tax savings opportunities, you can sell or trade them on your exchange of choice.
Then, import the transaction(s) into CryptoTrader.Tax and re-run your tax reports! You will then be able to see how much harvesting that loss reduced your net gains.
Let’s summarize this article by answering a few frequently asked questions about cryptocurrency tax-loss harvesting.
Does the wash sale rule apply to cryptocurrency?
Based on current IRS guidance, it’s reasonable to assume that the wash sale rule does not apply to cryptocurrency.
Can I use LIFO for cryptocurrency?
The IRS allows investors to use LIFO if they are able to specifically identify their tokens. For more information, check out the IRS FAQ on crypto.
Is there a limit to tax-loss harvesting?
Tax-loss harvesting can be used to offset 100% of capital gains for the year and up to $3000 of personal income. Any net losses above this can be rolled over into future tax years.
Is tax-loss harvesting a form of tax evasion?
No. Tax-loss harvesting is a common strategy that can help investors reduce their tax liability. Tax evasion is considered a criminal act and often occurs when taxpayers make false claims on their tax returns.
It is important to keep in mind that in the U.S. the tax year ends on Dec. 31st—even though the filing deadline isn’t until April 15th. If you want to claim losses this tax year, you’ll need to take action before New Year’s Day.
Many investors delay only to realize that they could have saved money on their tax bill if they would have sold or realized losses back in December. By that point, it’s too late for them to take advantage of tax-loss harvesting.
Don’t let this happen to you! You can see all of your tax-loss harvesting opportunities by creating a free tax report with CryptoTrader.Tax today. There’s no need to enter your credit card information until you’re ready to file your return.
Disclaimer: This guide is provided for informational purposes only. It is not intended to substitute tax, audit, accounting, investment, financial, nor legal advice.