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In recent months, the Federal Reserve has created stricter policies while also increasing interest rates by a considerable amount in an attempt to curb high inflation. As is the case with nearly all financial markets, the crypto market has been hurt by the rising interest rates as well as the worsening economic conditions.
Recently, the total market cap for cryptocurrencies dipped below $1 trillion, which marks the first time that this has occurred since January 2021. Currencies like Ethereum and Bitcoin are at their lowest prices since December 2020. Now that we're in bear market territory, it's time to utilize a strategy like crypto tax-loss harvesting.
Crypto tax-loss harvesting is a popular investment strategy that involves selling assets at a loss to effectively offset capital gains from other investments. People who use this tax strategy are able to reduce their total tax liability.
When you perform crypto tax-loss harvesting, you can reduce the amount of taxes you owe by selling assets at a price that's lower than what you paid for them, which can be helpful if you have any capital gains for the year. Keep in mind that realized gains can be taxed. Selling assets at a loss lets you accrue capital losses, which will directly offset your capital gains.
It's common for crypto investors to use this tax strategy toward the end of a given tax year or when the broader market has dipped by a considerable amount. If you use the right tool or piece of software, you can lower your taxes with crypto tax-loss harvesting.
If you're worrying about the possibility of crypto tax-loss harvesting being illegal, the truth is that this strategy is completely legal and isn't considered tax evasion. However, you'll need to adhere to specific wash sale rules if you want to properly use crypto tax-loss harvesting to reduce your income taxes for the year. These rules can differ from country to country.
When looking at the tax laws in the U.S., U.K., Canada and Australia, there are different capital loss limits that apply in each of these countries.
The U.S. doesn't place a limit on the amount of capital losses that can be used to effectively offset capital gains. On the other hand, some special rules apply if the total capital losses you accrue are higher than your capital gains. In this situation, you'll only be allowed to use $3,000 of capital losses to offset capital gains. Any remaining losses can be carried forward into future tax years.
In the U.K., a capital gains tax allowance that amounts to £12,300 is available for every individual. If the amount of capital gains you earn is higher than the tax allowance amount, you can use your capital losses to reduce your capital gains until they’re under the allowance. At the moment, there isn't a limit on the amount of capital losses you can use for crypto tax-loss harvesting.
Capital losses can be used to offset your capital gains if you live in Australia. There isn't a limit to this option. However, your capital losses must be used up before you can carry them forward into future tax years. What this means is that you're unable to carry capital losses forward if capital gains still remain.
The capital loss rules for Canada are somewhat unique in that it's only possible to offset half of your total capital losses. However, there isn't a maximum amount that can be offset against capital gains. If your losses exceed your gains for a financial year, these losses can be carried forward indefinitely.
Cryptocurrencies are considered to be a capital asset, which means that they function like stocks or real estate. Crypto gains or losses can only be realized after the currency is traded, sold or spent. Let's say that you currently hold a cryptocurrency that’s lost 50% of its value since you purchased it. This isn't realized as a crypto loss until you trade or sell your holdings.
Crypto tax-loss harvesting is a useful strategy that can help you offset your capital gains and reduce the amount of taxes you owe on your annual tax return. Keep in mind that harvesting is still possible even if you don't have any capital gains for the year. Harvesting for additional losses can also help you reduce your taxable income, or potentially offset the gains you've accrued from stocks or other asset types.
For example, let's say that you have $8,000 in capital gains this year, with a certain amount of ETH that's currently valued at $3,000 less than the amount you originally paid for it. In the event that you decide to hold the amount of ETH you currently have, you’ll be tasked with paying taxes on $8,000 of your capital gains.
You can, however, choose to use the crypto tax-loss harvesting strategy to harvest the ETH losses you've accrued. With this strategy, you would sell your current ETH holdings, which will allow you to obtain $3,000 in capital losses. As such, your capital gains would drop to $5,000, which should significantly reduce the amount of taxes you owe.
As with any tax strategy, there are benefits and potential risks that you should be aware of before you perform crypto tax-loss harvesting.
The main benefit of the crypto tax loss harvesting strategy is that you'll be able to lower your capital gains taxes. However, additional perks are available, depending on your country.
For instance, it's possible for you to offset some of your capital losses against your income, which may place you in a lower tax bracket. By dropping to a lower tax bracket, the taxes you owe would be reduced by a considerable amount.
Keep in mind, however, that crypto tax-loss harvesting doesn't necessarily allow you to avoid paying capital gains taxes indefinitely. The purpose of this strategy is to defer these taxes. By deferring your capital gains taxes, you'll have more money every year to use for crypto investing purposes.
While this tax strategy can be highly beneficial, there are also several potential risks. As long as you adhere to the necessary wash sale guidelines, you won't receive a visit from tax officials.
However, performing numerous purchases and sales of crypto means that your transaction fees will build up. Depending on the exchange you're using, these fees can be as high as 4% for every transaction. If you want to make sure that you're actually saving money, it's essential that you take these fees into account when calculating how much crypto tax-loss harvesting will reduce your tax bill.
As touched upon previously, crypto tax-loss harvesting doesn't eliminate your capital gains. You'll still be required to pay taxes on these gains at a later date. When you eventually sell crypto assets that you bought back, you'll need to pay taxes on your capital gains.
In the event that you buy crypto at a much lower price because of the recent dip, your capital gains may eventually be much larger than anticipated. Depending on how large these gains are, they may effectively cancel out your original tax savings from this strategy.
In order to take full advantage of the crypto tax-loss harvesting strategy, you'll need to adhere to a crypto wash sale rule, which can differ from country to country. This rule states that when a taxpayer ends up harvesting losses on a security or stock but decides to buy the same asset within 30 days of the sale, the IRS won't allow these losses to be deducted.
This rule was directly put in place to discourage taxpayers from selling assets solely to obtain the tax benefits of doing so. Let's say that you have a high amount of capital gains for the year. If so, you may look at your holdings and find that you also have an ample amount of unrealized losses.
In this situation, these cryptocurrencies could be sold to obtain a realized loss. You could then buy all of these currencies back at the reduced price before the crypto increases in value. By taking advantage of a wash sale, the capital losses you've gained aren't actually losses, since you've invested your proceeds from the sale into the exact same asset. These losses would be artificial losses, but could still be used to lower your tax bill.
Tax offices understand how easy it is to exploit crypto tax-loss harvesting, which is why many have implemented wash sale rules. These rules can stop an investor from taking advantage of a wash sale.
Let’s say that earlier in the year, you purchased $15,000 of Bitcoin. Eight months later, your holdings may only be worth $8,000 — thanks to the bear market, which means that you have the ability to use crypto tax-loss harvesting on $7,000 in unrealized losses. The price that you purchased Bitcoin at would be considered the cost basis. The current price is known as the fair market value. Any difference between these two prices is known as harvestable losses.
If you want to harvest your losses, you'll need to sell your Bitcoin before the current tax year has ended. In the U.S., the tax year ends on December 31. In Australia, the tax year ends on June 30. Some of the many tools that can make it easier for you to take advantage of crypto tax-loss harvesting include Koinly, ZenLedger, Taxbit, TokenTax and CoinTracker.
To start using Koinly, create a free account, after which you can sync your crypto wallets with the platform. Once your wallets and any exchanges you use have been added, your short-term and long-term capital gains will be calculated. The same is true of your crypto income, capital losses and expenses. All of these details will be displayed on the tax report page.
You can also use the Koinly tool to track any unrealized losses and gains you have with your crypto holdings. Koinly will implement the specific cost basis method that applies to your location. If you live in the U.K., Koinly uses the Share Pooling technique.
Keep in mind that you can change the method that the tool uses by navigating to Settings. Once it comes time to file your taxes, you'll be able to download your tax report from the tax report page. For U.S. taxpayers, this report will include Form 8949 and Schedule D.
ZenLedger is another popular tool that assists investors in taking advantage of the crypto tax-loss harvesting strategy. It allows users to identify how much unrealized capital loss they have with every token they hold. You can use these details to determine if you’d like to realize this loss. This process can be completed in three easy steps.
First, launch the tool, which you can do by selecting the tax-loss harvesting area on your ZenLedger dashboard.
Then, read the results in the harvesting report (via a Google spreadsheet). Every tab in this spreadsheet shows your capital losses and gains with your preferred accounting method.
The third step in this process involves deciding what action you'd like to take after viewing the report. For instance, you could choose to show this data to your current tax professional to explore all of your options. You could also begin by selling your current crypto holdings. Keep in mind that ZenLedger doesn't tell you what wallet or exchange to use when selling your assets.
TaxBit makes it easy for investors to use the crypto tax-loss harvesting strategy with its Tax Optimizer tool, which allows you to identify when the value of an asset drops below the purchase price. You can also set your preferred accounting method. When you use the Tax Optimizer tool, you can view your short-term and long-term capital gains, understand what tax-loss harvesting options you have, and see all of your unrealized losses and gains.
CoinTracker makes it relatively simple for users to perform crypto tax-loss harvesting. You can sync your profile to the CoinTracker dashboard to view your holdings at a glance. This allows you to easily identify current crypto holdings that can be harvested for a loss. You can then sell unrealized losses for a stablecoin, crypto or fiat currency, and buy back the same asset at the same amount. Once you’re done, you can send the assets back to your wallet.
While crypto tax-loss harvesting shouldn't be exploited constantly, the best time to use this tax strategy is when market conditions are in a downturn. This strategy is an effective way to use your unrealized losses to make sure that your capital gains aren't immediately taxed. When the market is poor, this strategy can help you maintain your assets.
As crypto sales in the U.S. aren't subject to the wash sale guidelines, there aren't many problems with implementing this strategy. When you do intend to apply this approach, make sure to use some of the tools mentioned previously to help you avoid making costly mistakes.
Crypto tax-loss harvesting is a highly beneficial tax strategy that allows you to defer capital gains taxes to a later date. If you want to make sure that you get through the crypto bear market without losing too many of your assets, there's no reason you shouldn't take advantage of the tax strategies at your disposal.
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