Investors in cryptocurrencies have had a difficult year as a harsh bear market eliminated approximately 65% of the value of Bitcoin. Every cloud has a silver lining, though, and in this case it is crypto tax-loss harvesting, a tactic that allows investors to sell assets for a loss in order to reduce their tax requirements.
Key Factors
- By selling assets at a loss during a market downturn or at the conclusion of a tax year, investors can use crypto tax-loss harvesting to reduce their tax obligations.
- Investors are allowed to sell an infinite number of assets and deduct up to $3,000 from their federal taxes in order to offset regular income.
- Further crypto market losses may be carried over to following tax years.
Investors can reduce their capital gains tax obligation to the United States government by using a practice known as tax-loss harvesting. To employ this approach, an investor must sell a financial asset at a loss in order to benefit from favorable market or tax-year timing. The loss can then be applied to future gains from the same investment or other lucrative transactions, or used to offset capital gains from other assets that generated a profit.
As an illustration, suppose an investor purchased a stock and suffered $5,000 in losses without realizing any other capital gains. The investor might carry over the remaining $2,000 of the loss to offset future capital gains or income and utilize the remaining $3,000 of the loss to offset ordinary income for that tax year.
Use Of Tax-Loss Harvesting in Crypto
Similar to stock investors, cryptocurrency investors can use tax-loss harvesting.
An investor who purchased a crypto token in April 2022 for $10,000 and held it in August 2023 for $7,000 would have had an unrealized loss of 30%. They might use the $3,000 they lost when they sold the investment to reduce other taxes they owe for the fiscal year. Additionally, the loss might be carried over to the following tax year.
It is not necessary to spend all of the capital losses incurred in cryptocurrency to harvest crypto assets. The tax obligation on other asset classes, such as stocks, bonds, and real estate, can be reduced by using losses.
There Are Some Limitations To Tax-Loss Harvesting
After deducting additional investment gains, the maximum amount of regular income that can be offset by tax losses is $3,000 ($1,500 if you’re married and filing separately). Investors must collect their cryptocurrency losses by the end of December since gains and losses are locked in at the conclusion of a tax year.
Since the cryptocurrency market continued to experience new lows throughout the year, this will be effective in 2022. After beginning the year at $47,000, the price of Bitcoin is still hovering around $17,000 in December. To harvest losses during a bull market, however, could be problematic, especially if the “wash-sale” rule applies to cryptocurrencies in the future (see below for more on cryptocurrencies and the application of this regulation).
A wash sale occurs when a person sells or trades a security at a loss and, within 30 days before or after this sale, either buys the same or substantially identical stock or security, or acquires a contract or option to do so. This Internal Revenue Service (IRS) rule prevents a taxpayer from deducting taxes for a loss on a security sold in a wash sale.
It should be highlighted that the wash-sale regulation will apply to the equity of businesses dealing in cryptocurrency. If you have any concerns about how to use tax-harvesting tactics most effectively, make sure to consult a qualified financial, accounting, and/or tax professional.
The Wash-Sale Rule And Cryptocurrency
The IRS wash-sale rule prohibits accepting capital losses on investments and then buying them again right away, as was previously mentioned. A wash sale also occurs when a person sells a security and, during the 61-day waiting period, their spouse or a corporation they control acquires an equivalent security.
However, the IRS makes it clear that the wash-sale regulations also apply to securities. Cryptocurrencies are categorized as property rather than securities because there aren’t any clear regulatory requirements. So, investors could buy their tokens back after a sale because the wash-sale regulation does not yet apply to trade in cryptocurrencies.
Final Thoughts
Investors in cryptocurrencies are licking their wounds after battling a year-long bear market. Despite this, not many investors are aware of the tax-loss harvesting approach, which can allow them to cut their tax liability and limit losses.
Crypto investment losses can be used to offset capital gains in other asset classes such as stocks. Additionally, investors can utilize them to deduct up to $3,000 in annual ordinary income. Investors who wish to employ this tactic must take action before the current fiscal year, which ends in December, expires.