Tax Loss Harvesting and Cryptocurrencies

Dec 26, 2023

Cryptocurrency Tax Loss harvesting

Did your cryptocurrency investments decrease in value this year? Don’t fret. You could realize those losses and use them to reduce your US taxes. You can then rebuy the crypto right away at the current market rate. This is known as tax loss harvesting and can be done with crypto holdings. This tax optimization strategy can save money, even for future years.

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)

Risks

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.

Example

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.

 

Views and opinions are current as of the date of this presentation and may be subject to change; they should not be construed as investment advice. There is no guarantee that objectives will be met.

This information discusses general market activity, industry or sector trends, or other broad-based economic, market, or political conditions and should not be construed as research or investment advice.

This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.

U.S. Taxes For American Expats E-book

FREE U.S. Tax Guide for Americans Abroad

The only e-book about U.S. Expat Taxes you need to read! Covers

1. Foreign Tax Credit vs. Foreign Earned Income Exclusion

2. The Additional Child Tax Credit. Get a $1,400 refund!

3.  What happens if I don't file?

and more...

Thanks for requesting our free tax guide! It will be delivered to your inbox shortly.

By continuing to use the site, you agree to the use of cookies. more information

The cookie settings on this website are set to "allow cookies" to give you the best browsing experience possible. If you continue to use this website without changing your cookie settings or you click "Accept" below then you are consenting to this.

Close