The Ultimate Guide to Cryptocurrency Tax Loss Harvesting
Engaging in tax loss harvesting with your cryptocurrency assets is one of the single most effective ways to reduce your tax bill for the year. It’s no secret that cryptocurrencies are extremely volatile. This and a number of other characteristics make it an unusually effective candidate for tax loss harvesting strategies. This guide outlines what tax loss harvesting is, how you can use it to reduce your bitcoin and crypto tax liability, and how you can use the CryptoTrader.Tax Tax Loss Harvesting tool to automatically detect your greatest opportunities for tax savings.
Tax Loss Harvesting - What Is It?
Tax Loss Harvesting is the practice of selling a capital asset at a loss to offset a capital gains tax liability. By realizing or “harvesting” a loss, investors are able to offset taxes on both gains and income. This is a tax reduction strategy commonly used in the world of stocks and securities.
John buys $1,000 of Apple stock and $2,000 of Tesla stock in a given year. While holding these investments, the value of John’s Apple stock rises to $1,500 while Tesla drops to $1,700. John sells all of his Apple stock for $1,500.
Without Tax Loss Harvesting
Without harvesting his losses in Tesla stock, John has a $500 capital gain for the year from the sale of his Apple stock. John pays taxes on all $500 of this capital gain.
With Tax Loss Harvesting
Rather than continuing to hold his Tesla stock, John can harvest his losses in Tesla by selling before year-end. Capital gains and losses get summed together for the year resulting in either a net gain or loss. John’s net capital gain is now only $200 for the year ($500 - $300). In this scenario, John only pays taxes on $200 of net capital gains rather than $500.
Tax Loss Harvesting With Cryptocurrencies
Cryptocurrencies are treated as property for tax purposes, exactly the same as stocks. 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. We discuss these below.
Wash Sale Rules
A wash sale results when you incur a capital loss, and then buy the same security back within a 30-day window before or after the capital loss is incurred. This rule is designed to prevent investors from taking capital losses in one year and then immediately buying back the stock. 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 wash sales rules do not apply to cryptocurrency at this time.
Cryptocurrencies are extremely volatile—more so than traditional assets. This volatility means that investors regularly have opportunities to realize and harvest capital losses. The difficult part for investors is identifying which of their 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. CryptoTrader.Tax has a tax loss harvesting tool built into the app that allows users to automatically identify which of their cryptocurrencies present the greatest loss harvesting opportunity.
Amy has made $15,000 in capital gains from investing in the stock market this year. Amy has also been investing in cryptocurrencies like bitcoin, XRP, and Ethereum. In December, Amy imports her cryptocurrency transactions into CryptoTrader.Tax and notices that her investments are down over $20,000 for the year. To harvest these losses, Amy trades all of her cryptocurrencies into Litecoin (thus incurring a taxable event and realizing her losses). Amy’s losses in cryptocurrency complete offset all of her stock market gains, and she’s left with a $5,000 capital loss for the year.
Net Capital Losses Up to $3,000 Offset Ordinary Income
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.
Using CryptoTrader.Tax To Automatically Detect Loss Harvesting Opportunities
You can use CryptoTrader.Tax to generate a complete report breaking down your biggest opportunities for tax loss harvesting. Start by connecting your exchanges and importing all of your cryptocurrency transaction data into the platform. The CryptoTrader.Tax historical price engine will assign cost basis to every single one of your cryptocurrency transactions.
Navigate To The Tax Loss Harvesting Tab
After generating your tax report, navigate to the “Tax Loss Harvesting” tab (pictured below). This report shows your largest loss harvesting opportunities in descending order. The report is comparing your cost basis in a specific cryptocurrency (how much you paid for it) to the current market price. Cryptocurrencies that have a cost basis much higher than the current market price present the greatest tax loss harvesting opportunity.
Sell or Trade Once Detected
Once you know which cryptocurrencies present the best tax savings opportunities, you can sell or trade them on your exchange of choice. Remember, selling or trading your crypto will trigger a taxable event and “realize” your losses in the asset.
Once you have completed the sale or trade, import the transaction(s) into step 2 of CryptoTrader.Tax and re-run your tax reports! You will then be able to see how much harvesting that loss reduced your net gains.
December 31st is the Cutoff - Time is of The Essence!
It is important to keep in mind that the tax year ends on Dec. 31st—even though the filing deadline isn’t until April 15th. This means that you must harvest your losses prior to the end of the year if you want them to impact that year’s taxes. 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 then it’s too late.
Don’t let this happen to you! You can see all of your tax loss harvesting opportunities by creating a tax report with CryptoTrader.Tax today.
You can learn more about how cryptocurrencies are taxed with our Complete Guide to Cryptocurrency Taxes.
Disclaimer: This guide is provided for informational purposes only. It is not intended to substitute tax, audit, accounting, investment, financial, nor legal advice.