Expert Advice on Collecting Crypto Tax Losses

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Although the entire cryptocurrency market lost around $1.4 trillion in 2022, some investors could have taken advantage of the decline to save big when filing their taxes through a strategy known as harvesting tax losses, which can be helpful to those with assets that have diminished in value. . It’s too late to take advantage of the 2022 tax year, but it doesn’t hurt to plan ahead for 2023.

To understand tax loss harvesting, you must first know how the Internal Revenue Service handles crypto gains and losses.

The IRS treats virtual currency as property. When you sell it at a loss, which means you couldn’t get back the amount you paid, the agency allows you to use those losses to offset profits made on other investments, called capital gains. . If capital losses exceed annual capital gains, investors can use the remainder to offset up to $3,000 of their regular income at tax time.

Capital gains are generally taxed at a lower rate than ordinary income, which includes what you earn at work or in a side gig.

Keep in mind that capital gains can only be offset by the same type of loss. Long-term gains, meaning you held your crypto for more than a year before selling, can only be reduced by long-term losses and short-term gains, meaning you sold your crypto before a year, are reduced by short-term losses.

Tax loss harvesting is a strategy that uses these rules to your advantage and crypto holders can use it in ways that other investors cannot.

What makes crypto different

Unlike stocks, the wash sell rule does not currently apply to crypto. This rule states that you are not allowed to claim a tax deduction if you sell a security at a loss and replace it with the same or “substantially identical” security 30 days before or after the sale, according to the IRS. .

This means that in theory you could sell your crypto, claim the loss, and redeem it without having to wait the usual 30 days.

However, beware of using this loophole to abuse the tax system, says Shehan Chandrasekera, a certified public accountant and head of tax strategy at crypto tax software firm CoinTracker.io.

If you frequently sell crypto at a loss and then immediately buy the same digital coin, the IRS would deny the tax benefit, Chandrasekera told CNBC Make It.

“I wouldn’t advise anyone to do that. I would just say wait a reasonable period of time,” he says. “Obviously you don’t have to wait the 30 days, but again, wait a reasonable amount of time before repurchasing the same coin.”

Some traders do this once a quarter, once a month, or every two weeks, Chandrasekera says.

Harvesting tax losses can be used to eliminate or reduce taxable capital gains

If you want to move forward with harvesting your crypto losses, it is important to understand how this could impact your tax bill.

If you sell cryptos that have increased in value and you have held them for more than a year, the profits will be subject to capital gains tax. Although capital gains are taxed at lower rates than ordinary income, it is still best to offset these gains against capital losses, as this can reduce or eliminate the amount of tax you owe.

Suppose you bought a crypto for $10,000 and then sold it for $13,000. You would face $3,000 in taxable capital gains. However, if you were to incur $3,000 in crypto trade losses, you would be able to offset the tax you owe, Chandrasekera says.

And if you have $10,000 in capital losses in one year, but only $3,000 in capital gains, you can carry the remaining $7,000 forward and use it to offset gains realized in the future, Chandrasekera says.

“You can carry it forward indefinitely to future years,” he says. “The second year, if you don’t have some earnings to offset, that’s fine. You can defer them until you die.”

It is important to note that collecting crypto tax losses requires careful tracking of how much you have paid and sold for your crypto. This can be difficult for some investors without the use of reputable software that can track your transactions for tax reporting purposes.

And remember that each investor’s tax situation is unique. Speak to your tax advisor before making any changes to your portfolio.

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