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Why Now Might Be the Right Time for Cryptocurrency Tax Loss Harvesting
This year has been tough for cryptocurrency investors, like a brutal bear market has wiped out about 65% of Bitcoin’s market cap. However, every cloud has a silver lining, and this time it comes in the form of cryptocurrency tax-loss harvesting, a strategy where investors can sell assets at a loss to offset tax requirements.
Key points
- Cryptocurrency tax-loss harvesting allows investors to sell assets at a loss during a down market or at the end of a tax year to reduce their tax liability.
- Investors can sell an unlimited amount of assets and deduct up to $3,000 to offset ordinary income against their federal taxes.
- Further losses in the cryptocurrency market may be carried forward to future fiscal years.
Harvesting tax losses It is a strategy used by investors to lower their capital gains tax liability to the United States government. To use this strategy, an investor will sell an investment to a loss of capital to take advantage of market or tax year timing. The loss can then be used to offset capital gains from other profitable activities or to offset future gains from that same investment or other profitable operations.
For example, suppose an investor purchased a stock and realized a $5,000 loss with no other capital gains. That investor could use the loss to offset $3,000 of ordinary income for that tax year and carry forward the remaining $2,000 loss to offset future capital gains or income.
Using Tax-Loss Harvesting in Crypto
Cryptocurrency investors can utilize tax loss harvesting in the same way as equity investors.
If an investor purchased $10,000 of a cryptographic token in April 2022 and held the same investment at $7,000 in December, which represents a 30% unrealized loss. By selling the investment at a $3,000 loss, they could use that $3,000 to offset other taxes owed from the fiscal year. The loss could also be carried forward to the next fiscal year.
Capital losses incurred in cryptocurrency must not be used exclusively for cryptocurrency collection. Losses can be used to reduce the tax due on other asset classes, such as shares, bondsand real estate.
Tax-Loss Harvesting Has Some Limitations
Tax-loss harvesting can only be used to offset $3,000 of ordinary income ($1,500 if you are married and filing separately) after offsetting other investment gains. Because gains and losses are locked in at the end of a tax year, investors must harvest their cryptocurrency losses by the end of December.
This will work well in 2022, as the cryptocurrency market has continued to hit new lows throughout the year. In December, Bitcoin is still trading just below the $17,000 level after starting the year at $47,000. In a bull market, however, it may be a risky strategy to harvest losses, especially if the ““fictitious sale” rule will apply to cryptocurrencies in subsequent years (see below for more information on cryptocurrencies and the application of this regulation).
This Internal Revenue Service (IRS) The rule prohibits a taxpayer from taking a tax deduction for a loss on a security sold in a sham sale, which occurs when an individual sells or trades a security at a loss and, within 30 days before or after such sale, purchases the same or a substantially identical security or stock, or acquires a contract or option to do so.
It should also be noted that shares of companies involved in cryptocurrencies will be covered by the wash-sale rule. Be sure to check with a financial expert, accountant and/or tax advisor if you have questions about the best use of tax collection strategies.
Cryptocurrency and the Rule of Fictitious Sale
The IRS wash-sale rule prevents investors from suffering capital losses on investments and then immediately repurchasing them, as discussed. Similarly, a wash sale also occurs if an individual sells a stock and the individual’s spouse or a corporation controlled by the individual purchases an equivalent stock during the 61-day waiting period.
However, the IRS specifically states that the wash-sale rules apply to securities. Due to the lack of clear regulatory guidance, cryptocurrencies are classified as property, not securities. This means that the wash-sale rule does not currently apply to cryptocurrency trading, so investors may be able to buy back their tokens after a sale.
The bottom line
Cryptocurrency investors are licking their wounds after struggling through a year-long bear market. However, many investors are unaware of the tax-loss harvesting strategy that can help minimize losses and lower their tax bill.
Losses on cryptocurrency investments can be used to offset capital gains in other asset classes like stocks. Investors can also use them to offset up to $3,000 per year in ordinary income. Investors looking to use this strategy should act before the current financial year ends in December.