What is Crypto Winter? – Tax tips and TurboTax videos

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You have probably heard of the crypto winter. But what exactly does that mean, and what does it mean for your investments and your taxes?

Key points to remember

A crypto winter has set in for cryptocurrencies, resulting in significant losses for many investors.

Selling at a loss may have tax consequences unique to cryptocurrency.

Investors who believe in the long-term potential of cryptocurrency can still use this downward market movement to reduce their tax bill through tax loss harvesting strategies without the negative impact of the shadow sell rule for crypto.

Cryptocurrencies have spent much of the past few years growing in popularity, largely mimicking the surge in cryptocurrency prices. However, the two trends quickly reversed in 2022, ushering in a so-called crypto winter that has digital currency investors wondering when the thaw will come and, in many cases, what to do with the crypto losses they have accumulated. .

What is a crypto winter?

A crypto winter, for the record, is a pretty loose term. It is often used in the same way as the bear market refers to a drop in the value of stocks. But unlike bear markets, which must meet specific parameters to be called that, a crypto winter basically just means a period of lower cryptocurrency prices.

How loose is a term? According to the outlet, there have been between one and five crypto winters since 2014.

Why is the crypto winter happening?

One way crypto winters are similar to bear markets is that many things can trigger them, there is usually no single reason why these downturns occur. Although it is unclear exactly what creates a crypto winter, two previous events in 2014 and 2018 had very different catalysts.

In February 2014, the now defunct Mt. Goxa, the Tokyo-based bitcoin exchange that at one time was responsible for most global bitcoin trading, suddenly halted all bitcoin withdrawals and eventually closed. trades completely before filing for bankruptcy. The many doubts about the security of crypto exchanges raised by the incident caused Bitcoin to lose almost 60% of its value in 2014.

Crypto winter 2018 is harder to pin down on one thing. Most cryptocurrency investors generally considered digital currencies to be in a bubble at the start of the year. Bitcoin had jumped nearly 1,400% in 2017; new coins, such as Ethereum (ETH) and its over 10,000% gain, had been even more explosive.

But many headlines have rattled cryptocurrency prices throughout the year, including the Japanese crypto market hack Coincheck, as well as major social media companies banning initial coin offering ads ( ICO) amid a host of related scams. The bubble burst was severe: Bitcoin crashed 70% in 2018 and closed around 80% from its January 2018 peak. year.

The crypto winter that began in late 2021 has its own unique causes.

What led to the last crypto winter?

The most cryptocurrency-specific engines of the current crypto winter have reared their ugly heads since the spring of 2022. a broader stock slump.

The bear markets for equities and cryptocurrencies don’t really seem to line up at first glance: the S&P 500 peaked in early January 2022, about two months after most major cryptocurrency prices peaked.

But Bitcoin’s drop in value has more mirrored that of the Nasdaq Composite, which peaked in mid-November 2021. Both reacted badly to the same factor: high inflation, which many (correctly) predicted would trigger a Federal Reserve interest rate wave. hikes. Bitcoin peaked just before November 10, 2021, briefly approaching the $70,000 level. It closed 2021 down more than 30%, or around $48,000. He was hardly alone.

If you lost money on cryptocurrency, what can you do now?

Cryptocurrency is a relatively new asset class, first stemming from the initial offering of Bitcoins in 2009. The investment category has seen a significant increase in activity, with individual investors around the world partaking both upward and, more recently, downward movements. But just because the market is downshifting doesn’t mean your money is necessarily lost.

If you have invested at a higher price than where your cryptocurrency is currently trading, you are in a losing position on paper. Just because your position is worth less than what you paid for, it doesn’t necessarily mean you lost money as you may not need to sell your cryptocurrency at a loss. If you choose to continue to hold your crypto for a longer period of time (something the crypto community colloquially calls HODLing or holding out for dear life during the high volatility seen in the crypto markets), you face no recognized loss. , you simply realize them on paper. The story changes if you choose to sell or trade your cryptocurrency, recognizing a capital loss. This converts a paper loss into a recognized loss, and with it, tax consequences.

Does crypto winter affect all cryptocurrencies?

The cryptocurrency market has suffered tremendously during the current crypto winter. The total crypto market capitalization peaked at around $2.9 trillion in November 2021, fell to around $2.2 trillion in early 2022 and currently sits at around $800 billion, a decline of more than 70% in just over a year.

It’s not a coin or two that’s holding the group back either: each of the top 25 cryptocurrencies has been down year-to-date.

But some do much better than others. While Bitcoin is down nearly two-thirds in 2022 and crypto Ethereum (ETH) is a little more extinct, several stablecoins have managed to hold their ground. The USD Coin (USDC) is mostly flat with some brief spikes in value throughout the year. Tether (USDT) was in danger of losing its 1-to-1 peg to the US dollar a few times this year, but has stabilized and is stable for the year as well.

How is crypto taxed?

Cryptocurrency is taxed the same as other capital investments. This means that if you buy, sell, or trade crypto in a taxable account, you will likely have capital gains or losses at tax time. Depending on how long you have held your crypto, your gain will be taxed using one of two different sets of tax rates.

Short-term capital gains tax rate: If you owned the cryptocurrency for a year or less before spending, selling, or trading it, any profit or loss is generally considered short-term . Short-term gains are taxed at the rate of your ordinary income between 0% and 37% in 2022 Long-term capital gains tax rate: If you’ve held the cryptocurrency for more than a year, all profits are generally long-term capital gains, subject to long-term capital gains tax rates of 0%, 15% or 20% for 2022. If you have capital losses, they may be used to offset equivalent capital gains or up to $3,000 per year of taxable income, with the unused balance carried forward to offset future capital gains or income. How the Wash Sale Rule Works With Crypto

When investing, it is typical for the value of your investments to rise and fall as markets move, developments occur or sentiment changes from day to day. If you hold an investment that has fallen in value but still believe it could improve in the long term, you might consider taking advantage of the short-term loss to reduce your taxable income this year.

The wash sale rule does not allow you to deduct losses on your tax return when you buy replacement securities within 30 days before or after you sell substantially identical securities. The tax base of the replacement titles becomes the new cost which is then increased by the non-deductible loss.

However, cryptocurrency is not treated as security for tax purposes. Instead, the IRS treats cryptocurrency as property, which means the wash sale rule does not apply.

Harvesting Tax Losses for Cryptocurrency

While the wash sale rule prevents investors from reaping losses on securities such as stocks and bonds, the wash sale rule does not apply to crypto because the IRS considers it property rather than a title. As a result, you are free to sell your crypto for less than you paid, recognize the loss on your tax return, and redeem your position without being subject to the wash sale rule.

TurboTax Tip: You can use capital losses to reduce your capital gains from other investments or up to $3,000 of other taxable income per year. If you have capital losses greater than this amount, you can carry them forward indefinitely, offsetting future gains or up to $3,000 of taxable income per year until you have used all the losses.

In the world of crypto investing, if you book a loss but still think the same crypto asset has long-term promise, you can buy it back at any time, even on the day of the sale, without being affected by washing it off. sales rules.

Down, but not out

If you are a long-term investor who believes in the potential of cryptocurrency, you can profit from downward movements in the cryptocurrency market. By using tax loss collection strategies, you can lock in capital losses on any cryptocurrency positions you may be holding and then immediately redeem the crypto assets to restore your positions. Since crypto currently avoids the fictitious sell rule that other securities must follow, you can sell and redeem your crypto immediately while incurring a loss on your taxes.

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