By taking advantage of tax loss harvesting, crypto investors can reduce their taxable gains. Tax loss harvesting is legal and practiced by many investors, but there are nuanced rules surrounding wash sales that you should be aware of. These rules vary depending on whether you are dealing with Bitcoin or another cryptocurrency, or traditional investments like stocks.
In this blog, we'll walk you through the process of crypto tax loss harvesting to help you pay as little in taxes as possible on your crypto gains.
Cryptocurrency Tax Loss Harvesting is a Term that Refers to What?
By selling off crypto holdings at a loss at the end of the year, investors can lower their taxable income for the year. An investor can reduce their taxable income by selling cryptocurrency at a loss, a strategy known as "tax loss harvesting." At the new, lower price, they may decide to repurchase the asset and hold onto it for future appreciation.
An overview of crypto tax loss harvesting is as follows:
- If you sell, trade, or spend crypto, like Bitcoin, you make a profit.
- You will be subject to capital gains tax on that profit, which is something you would rather avoid.
- A portion of your cryptocurrency holdings have depreciated in value since you first bought them, resulting in an unrealized loss.
- You suffer a loss when you sell, trade, or spend your Bitcoin.
- This capital loss can be used to reduce the capital gain you have accumulated.
- As a result, you do not have to worry about paying tax on that profit.
- The Bitcoin you used to generate a tax loss may be purchasable again, making the loss theoretical.
What You Need to Know about Crypto and Tax Loss Harvesting:
We can better grasp tax loss harvesting by comparing two hypothetical taxation scenarios: one with tax loss harvesting and one without.
Through the course of the fiscal year:
Brad, a crypto investor, purchased 1 BTC for $20,000 and 1 ETH for $1,000. ETH prices surge to $2,000 while BTC prices drop to $18,000. Brad sells his Ether at $2,000 to cash in on his profit.
Brad must pay Capital Gains Tax on his $2,000 ETH profit if he does not use tax loss harvesting.
But he does not want to, so he uses tax loss harvesting on his cryptocurrency to reduce his taxable income. To accomplish this, Brad sells his single bitcoin (BTC) for $18,000, taking a $2,000 loss on the transaction. Since his ETH gain is less than his capital loss, he will owe no capital gains tax.
NOTE: Earlier, we mentioned that investors can repurchase their asset; however, the rules in your jurisdiction may prohibit you from doing so if the wash sale rule is in effect.
Just What is a "Wash Sale”?
When an investor sells an asset at a loss and then buys back the same asset or one that is essentially identical to it, they have committed what is known as a "wash sale."
If you have a large capital gains tax bill coming up, for instance, you could quickly look through your unrealized losses to determine how many crypto assets you need to sell, sell these to create a realized loss, and then buy them back at the lower price before the market changes again. Since you put the money back into the same asset, you have exactly the same holdings as before and cannot be said to have suffered a loss. However, you can use the fictitious loss you have accumulated to lower your tax liability.
As a result, many tax authorities have implemented stringent rules to prevent investors from generating fake losses by means of a wash sale, which is surprisingly easy to exploit. According to this rule, traders cannot deduct losses from the sale and subsequent purchase of cryptocurrency or any other asset within a specified time frame.
This is referred to as the "wash sale rule.”
Is the IRS Wash Sale Rule Applicable to Cryptocurrency?
The IRS has a wash sale rule in place. Under US law, a "wash sale" occurs when an individual US investor sells or trades an asset at a loss and then buys back a "substantially identical" asset within 30 days. A trader who does this will not be able to deduct capital losses. However, the securities wash sale rule in the US only applies to stocks, bonds, and other financial instruments in their current form. For this reason, the IRS wash sale rule would prevent you from deducting any losses you might have incurred if you bought GME stock, sold it at a loss, and then repurchased it.
The IRS does not consider cryptocurrency to be a security, but rather a form of property. Thus, cryptocurrency is excluded from the IRS's wash sale rule at the present time. To minimize your taxable gain, you can "tax loss harvest" your cryptocurrency by selling it at a loss and then repurchasing it. Thus, the wash sale regulation will be applicable to crypto-related securities traded on stock exchanges.
Read more: How a Wash Sale Rule Cleans Your Tax Loss
Do not start celebrating just yet!
There's a chance that things might change soon. US politicians are currently examining the crypto industry's existing tax structure with an eye toward closing such loopholes.
Learn more: New Crypto Tax Bill
How Do I Sell Cryptocurrency to Minimize Taxes?
The crypto market's volatility means that not every investment will skyrocket. Investors with experience will sell assets during market downturns for a loss in the knowledge that they can use the proceeds to offset future gains. A paper loss can be avoided by the investor simply repurchasing the asset at the lower price.
You should keep tabs on your realized and unrealized gains and losses to determine when to sell. Only when you actually sell, trade, or spend your cryptocurrency do you have a gain or loss.
Up until now, your profit or loss has not been fully appreciated. Since you have not sold your cryptocurrency yet, you have not experienced the gain or loss associated with the change in its value. By keeping tabs on both your unrealized and realized losses and gains, you can keep an eye on your taxable gains and seek ways to offset them.
When Should I Do a Crypto Tax Loss Harvest?
Many cryptocurrency investors choose to "harvest" their losses once a year. They will check their cryptocurrency portfolios as the end of the fiscal year draws near to determine if they have any unrealized losses that can be deducted from their taxable income.
TIP: To make the most of tax loss harvesting as a cryptocurrency investor, you need to take advantage of the market's volatility throughout the year. Always keep a watch on your unrealized losses and when the time is right, buy low.
How Does Tax Loss Harvesting in the Cryptocurrency Industry Help?
Tax loss harvesting bitcoin has some advantages beyond the reduction in capital gains tax payments. Capital losses can be used to reduce the amount of capital gains or even to reduce the amount of income tax owed in some countries.
Here in the United States, for instance, taxpayers can lower their taxable income by up to $3,000 annually by deducting capital losses from their regular income. You can reduce your tax bill by deferring your losses until you have gains in a future tax year.
Is Tax Loss Harvesting for Cryptocurrencies Risky?
A tax audit is not something you have to worry about if you follow the wash sale regulations. Loss harvesting in cryptocurrencies is allowed by the IRS.
There are, however, drawbacks to this option. When there is a high volume of trades in cryptocurrency, transaction costs rise. This can be as much as 4 percent of each exchange on some markets. You will want to factor this into your math to make sure the transaction fees are not canceling out any tax savings you might realize.
In addition, if you lower your cost basis at the time of the repurchase, you may end up with a larger capital gains tax obligation in the future.
Does Crypto Tax Loss Harvesting Have Any Limits?
You should be aware of the capital loss offset limits before you decide to sell all of your underperforming cryptocurrency at a loss.
In other words, the amount of capital losses that can be utilized to offset net capital gains in a given fiscal year is capped.
Cryptocurrency Investment and Tax Loss Harvesting—Can You Escape Taxes?
No, Cryptocurrency tax loss harvesting is entirely legitimate. In order to offset your capital losses, you must comply with the wash sale requirements of your nation.
Resource: Can the IRS Track My Crypto?
How do Short-term and Long-term Crypto Tax Loss Harvesting Compare?
The Internal Revenue Service (IRS) requires you to offset profits and losses of the same kind in the order in which they occurred, and short-term and long-term gains are taxed at different rates. As a result, you'll reduce your short-term losses first by increasing your short-term gains, then your long-term losses by increasing your long-term gains, and so on. Any remaining capital losses can be used to offset gains from a different type of capital investment.
Knowing how long you've held cryptocurrency before selling it will allow you to take advantage of tax loss harvesting and potentially reduce your tax liability.
Can I Deduct my Cryptocurrency Investment Losses Against My Stock and Asset Gains?
This varies by locality, but in most cases, yes! In the United States, gains and losses of the same sort may be canceled out (so generally in the same tax rates). Therefore, if you have capital gains from stocks and losses from cryptocurrency, you can offset the losses against the profits.
Can I "Harvest" Bitcoin Losses for Taxes?
Harvesting tax losses for Bitcoin is possible. With respect to taxes, tax loss harvesting can be performed on any cryptocurrency.
When does one need to know whether or not they can take advantage of cryptocurrency tax loss harvesting?
You can only deduct losses from profits if you realize them (by selling, trading, or spending your crypto) before the end of the fiscal year (EOFY). It is important to remember that the fiscal year can be different depending on where you are.
Rest assured! Crypto tax loss harvesting is not a form of tax evasion. This is a common practice among stock traders. Currently, the wash sale regulation does not apply to cryptocurrency transactions, which is the only distinction between stocks and cryptocurrencies. You should be wary of making a loss by selling your cryptocurrency right now because it's so easy to convert Bitcoin to Ethereum and vice versa. After 30 days, you can still purchase back the security and record a paper loss. Until a wash sale law is implemented for cryptocurrencies, however, doing so is not only not tax evasion but also one of the best tax-saving techniques you can have.
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