What is Tax Loss Harvesting? And how does it relate to Cryptocurrencies?
Tax Loss Harvesting is a system used to offset your capital gains by decreasing your taxable income, essentially tax-loss selling. This would consequently reduce your income taxes. Cryptocurrency tax loss harvesting means selling your underperforming cryptocurrency to harvest and realize a loss and then applying that loss to offset taxes on other gains or your regular income.
Essentially, the crypto tax-loss harvesting strategy is when you sell your current cryptocurrency holdings at a loss (meaning you bought them at a higher price than where they currently are) and immediately repurchase them.
Thus, selling it at a loss results in a capital loss, which can now be used to offset capital gains from other investments, stocks, or crypto sales.
Even if you don’t have any capital gains this year or you don’t anticipate any, there’s still a benefit to the tax-loss harvesting strategy – as even without capital gains taxes, up to $3,000 can be used to offset ordinary income.
Capital losses can also offset ordinary income up to $3,000 annually ($1,500 if you are married, filing separately, or single). Any unused losses can then be carried forward to future years.
Cryptocurrencies and the Wash Sale Rule
The Wash Sale Rule states that if you sell or trade stock or securities at a loss, you can’t buy substantially identical securities (be it individual stock or other identical security) within 30 days before or after the sale. If you make this type of purchase within 30 days, the loss on the sale of the stock or securities is disallowed, and the basis of your new stock or securities is the same as the basis of the stock or securities sold. The Wash Sale Rule is a nasty little piece of tax code. In effect, it says that if you sell a stock for a loss, you can’t repurchase it for 30 days. If you repurchase it within this time, the loss is disallowed for tax purposes, and your cost basis would remain the original.
In a stroke of luck for crypto investors, the Wash Sale Rule only pertains to securities and, therefore, doesn’t apply to cryptocurrencies. Cryptocurrency is considered a property by the IRS, not a security, so the Wash Sale Rule does not apply to crypto right now.
For instance, the tax strategy would not work for mutual funds or exchange-traded funds, for which the cost basis would remain unchanged as the wash sale rule would apply.
The US government is aware of this tax loophole and has attempted to close it – but so far, such attempts have not been successful.
Deadline Realize Losses For Cryptocurrency
To realize cryptocurrency losses, you must sell your crypto at a loss by December 31st. It would be best to market your losing crypto within the calendar year to harvest the losses in your next tax return.
Due to the high volatility of digital assets and the Wash Sale Rule not applying to crypto, selling and then rebuying can work very well for one’s cryptocurrency investments.
(but of course, prudent asset allocation would limit the amount allocated to cryptocurrencies)
Tax Loss harvesting resets the holding period: whether the capital gain is a short-term gain vs a long-term gain dictates how it will be taxed. This means that if the holding period is less than a year, it will be taxed at the short-term capital gains tax rate of 10-37% (i.e. taxed as ordinary income), and over a year, it will be the long-term capital gains tax rate of 0-20%.
So, we can kind of game the system by harvesting yearly losses. But that will keep you in the short-term holding period with the higher tax rate. If the market increases and you sell at a gain, you’ll pay the higher short-term capital gains tax on the increase.
Who would most benefit from Cryptocurrency Tax Loss Harvesting?
Higher-income earners with significant gains can benefit more.
Taxpayers in low-income brackets pay little or zero long-term capital gain taxes. Therefore, they won’t get much of the benefit.
The long-term capital gain tax of 0% applies under those scenarios and incomes (including both ordinary income and capital gains):
– You are single or married filing separately, and your taxable income is less than $44,625,
– You are married filing jointly, and your taxable income is less than $89,250 or
– You are head of household, and your taxable income is less than $59,750. If your taxable income is above those thresholds, considering to harvest crypto-losses would make sense for you.
For illustrative purposes, let’s assume that you bought $8,000 worth of Bitcoin (BTC) when the price was $8,000. The position is now $3,000. You still want to own BTC, so selling now does not make much sense.
However, you can sell your BTC to capture a $5,000 capital loss and immediately repurchase it. The Wash Sale Rule (30 days is the rule in stocks) does not apply to crypto transactions, so your cost basis will now be $3,000.
You can then use the $5,000 realized capital loss (be it short-term losses or long-term losses) to offset any capital gains, short-term or long-term. Assuming a 15% tax rate (most likely for a long-term capital gain), you have tax savings of $750.
Further, you can deduct up to $3,000 from your income if you didn’t otherwise have gains. Any unused capital losses ($2,000 in this case) can be carried forward into future tax years.
You can schedule a free call with us for advice on your US tax filings in 2024.
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