Crypto tax-loss harvesting might help you to reduce your tax bill by realizing losses on cryptocurrencies that have fallen in price since you acquired them.
However, there are many nuances to crypto tax-loss harvesting and pitfalls to avoid, so read on to learn more about how crypto tax-loss harvesting works and how to do it according to US tax law so you can start saving money on your taxes today.
Key takeaways
- Crypto tax-loss harvesting is a method used by cryptocurrency investors to reduce their tax bills by selling cryptocurrencies at a loss to offset potential capital gains.
- The process involves identifying cryptocurrencies that have decreased in value since acquisition and then selling them to realize the loss, potentially offsetting capital gains from other investments.
- While the IRS has yet to make an official statement on the application of the wash sale rule to cryptocurrency, current interpretations suggest that crypto is likely exempt from this rule, but may change in the future based on statements from the White House.
- To claim a loss for a specific financial year, one must sell the respective assets before the end of the last date of that tax year.
What is crypto tax-loss harvesting?
Crypto tax-loss harvesting is a strategic approach cryptocurrency investors use to reduce their tax bills. Essentially, it involves selling certain cryptocurrencies at a loss to offset potential capital gains from other investments. Once these losing positions are sold, the realized losses can counterbalance any gains in the investor’s portfolio.
The intention behind tax-loss harvesting crypto is to minimize the overall tax liability for the financial year associated with cryptocurrency trading. But as we will discover in this guide, there are many nuances and important considerations to be aware of to maximize the benefit from tax-loss harvesting your crypto losses.
How can I tax-loss harvest crypto?
Assuming that you already have a realized capital gain that you need to pay taxes for, you can tax-loss harvest crypto to reduce your tax bill by following these steps:
- Identify one or more cryptocurrencies that have fallen in price since you bought the asset initially
- Calculate the loss you can claim if you sold at the current price
- Decide which cryptocurrencies you want to sell based on the findings from the previous step
- Sell one or more cryptocurrencies to realize the capital loss on those assets
Let’s explain this with an example to understand better how tax-loss harvesting works in practice.
John bought 0.5 BTC in January of 2023 when the price of Bitcoin was $18,000. He later bought 8 ETH in April when Ether was $2,500. In June, he sold the 0.5 BTC bought earlier and realized a capital gain of $5,500.
All his transactions are seen in this table:
| Type | Date | Amount | Total Price | Cost Basis | Profit/Loss |
|---|---|---|---|---|---|
| Buy | 2023-01-10 | 0.5 BTC | $9,000 | ||
| Buy | 2023-04-15 | 8 ETH | $20,000 | ||
| Sell | 2023-06-15 | 0.5 BTC | $14,500 | $9,000 | $5,500 |
Since John has now realized a capital gain of $5,500, he must also pay short-term capital gains tax on this amount since he held the coins for less than 12 months.
However, since the price of Ether has declined from the day he bought 8 ETH, he can now sell his coins and claim the loss to offset the gains from BTC.
On August 1, John decided to sell 8 ETH for a total price of $14,000. Since he wanted to maintain his exposure to Ether, he bought 8 ETH back the next day at the same price.
| Type | Date | Amount | Total Price | Cost Basis | Profit/Loss |
|---|---|---|---|---|---|
| Buy | 2023-01-10 | 0.5 BTC | $9,000 | ||
| Buy | 2023-04-15 | 8 ETH | $20,000 | ||
| Sell | 2023-06-15 | 0.5 BTC | $14,500 | $9,000 | $5,500 |
| Sell | 2023-08-01 | 8 ETH | $14,000 | $20,000 | -$6,000 |
| Buy | 2023-08-02 | 8 ETH | $14,000 |
Assuming he didn’t make any other transactions during the tax year, his net capital loss during 2023 becomes $500 which means he will not pay any capital gains tax on his cryptocurrency investments while still owning 8 ETH at the end of the tax year.
Remember that not all countries allow claiming capital losses if you buy back the same cryptocurrency shortly after selling it for a realized loss, such as Canada and Ireland.
When should I tax-loss harvest?
There are two things you need to track to know when to tax-loss harvest your cryptocurrencies:
- The realized capital gain/loss during the current financial year
- The unrealized capital gain/loss for the cryptocurrencies in your current portfolio
The realized capital gains must be calculated for all transactions you have made during the tax year. After calculating this for all transactions considered disposal (such as selling, swapping, and spending), simply summarize the values to find your net realized gain/loss until today’s date. If the value is positive, you have made a net realized gain, and if the opposite, you have made a net realized loss.
You should track your unrealized gain/loss for all the cryptocurrencies you still own to ensure you take advantage of all tax-loss harvesting opportunities you may have. The unrealized gain/loss is calculated as the acquisition cost (what you paid initially) subtracted from the current market price.
Generally, the best time to tax-loss harvest is towards the end of the tax year when you can evaluate your annual capital gains and losses in more detail. This timing gives a clearer picture of how much loss must be realized to offset the gains.
However, given the volatility in the crypto market, you might get good opportunities to tax-loss harvest at any point during the year, such as when short-term dips occur in the market. If you want to maximize the potential of tax-loss harvesting to reduce your tax bill, you must keep an eye on your realized and unrealized gains throughout the year.
Remember that it’s also essential to be aware of potential market rebounds; selling an asset during a dip only to see it recover shortly afterward can be counterproductive if you need to buy the asset at a higher price than you sold.
How often should I tax-loss harvest crypto?
Due to the volatility of the cryptocurrency market, price swings can occur rapidly and provide multiple opportunities throughout the year for harvesting losses. For active traders or those with a diverse portfolio, a monthly or quarterly review can help identify positions ripe for harvesting.
On the other hand, if you have a more static portfolio or engage in longer-term holding strategies, semi-annual or annual reviews might be sufficient for your personal needs and goals.
However, in either case, it might be a good strategy to review your tax-loss harvesting opportunities when there is a big dip or crash in the market since some of the best opportunities to reduce your taxes might come early or in the middle of the financial year. You can use a crypto tax calculator like Coinpanda to automatically track your realized and unrealized gains in real-time through the entire tax year to identify the best tax-loss harvesting opportunities easily.
How much of my losses can I harvest?
In most countries, including the US, you can harvest and offset all capital gains with capital losses in a given tax year. There is also no limit on the total amount of losses you can harvest, so you are free to sell as many assets at a loss as you want.
If your losses exceed your gains, you might be allowed to deduct a specified amount of the net loss against other forms of income. For instance, in the US, individuals can deduct up to $3,000 (or $1,500 if married filing separately) of net capital losses against ordinary income annually. Any excess loss can typically be carried forward to offset gains in subsequent years.
Does the IRS wash sale rule apply to crypto?
The IRS has implemented a wash sale rule in the tax code that prohibits investors from claiming a loss on the sale or trade of a security if they buy a “substantially identical” security within 30 days before or after the sale. Similar to other countries that also have incorporated a wash sale rule, the goal is to prevent taxpayers from claiming artificial losses.
Since the IRS has defined cryptocurrency as property and not as a security, most tax professionals argue that the wash sale rule shouldn’t technically apply since crypto is not classified as a stock or security. Furthermore, the IRS has not made an official statement on cryptocurrency and the wash sale rule yet, so for now, it should be safe to assume that the rule does not apply to cryptocurrency.
That is, as of now. Many US crypto investors might have read the statement from President Joe Biden in March of 2023 that Congress should cut “tax loopholes” that currently benefit wealthy crypto investors. Although the tweet from the President didn’t specifically address which changes in the tax rules he referred to, it’s quite likely that it was related to wash sales and harvesting losses from crypto assets that have declined in price.
This is still just a proposed change, and nothing will come into effect before the proposal has passed through the judicial system. At Coinpanda we keep a close eye on all the latest news and developments regarding crypto taxes, and we will update this article whenever there are any developments.
Benefits of crypto tax-loss harvesting
There are mainly four ways that crypto tax-loss harvesting may benefit you:
- Reduced capital gains tax: The most obvious benefit is that you can offset all your capital gains with capital losses, resulting in either reduced capital gains tax or, in some cases, not even paying capital gains tax if your losses offset all your gains.
- Reduction in taxable income: In the US, taxpayers can offset up to $3,000 in capital losses against ordinary income each year, which may provide a substantial tax reduction for many individuals.
- Deferring tax obligations: By strategically harvesting losses, investors can defer paying taxes on gains to future years. This can be particularly beneficial if the investor anticipates being in a lower tax bracket in upcoming years.
- Carryforward of excess losses: In most countries, including the US, the excess loss can be carried forward to future years if an investor’s harvested losses exceed their gains in a given year.
Risks of crypto tax-loss harvesting
Although there can be many benefits from harvesting crypto losses, there are also several potential risks and downsides that investors should not ignore.
- Missed upside potential: In a volatile crypto market, assets sold to realize a loss might rebound quickly. Selling off at a low could mean missing out on subsequent gains if the cryptocurrency’s price recovers shortly after the sale.
- Overcomplicating tax reporting: Continuously tax-loss harvesting can lead to a more complex portfolio, and an increased number of transactions can make it more difficult and time-consuming to calculate your crypto tax accurately.
- Increased transaction fees: Regularly buying and selling assets to realize losses can result in increased transaction fees, which might diminish the overall tax savings.
- Wash sale uncertainties: Given the statements from the White House about possible changes to crypto and wash sales in the future, there’s a risk that tax authorities might retrospectively apply such rules and potentially negate the benefits of the harvested losses.
- Potential audits: Frequent selling and buying of assets might raise red flags with tax authorities and increase the likelihood of an audit. While the practices might be legitimate, audits can be time-consuming and stressful.
- Tax rate changes: Long-term capital gains are taxed at a lower rate than short-term capital gains in the US and many other countries, so realizing a short-term loss to offset a short-term gain might not be as beneficial if you expect to realize long-term gains in the near future.
Short vs. long-term gains when tax-loss harvesting
The IRS says short-term losses should first be used to offset short-term gains, and similarly, long-term losses should first offset long-term gains. If there is an excess of losses in one category, they can be used to offset gains in the other.
This is important since you pay a different tax rate on short-term and long-term capital gains in the US, so the effective amount of tax you pay directly correlates to which category of gains is offset by your losses.
Can I do tax-loss harvesting for NFTs?
Given that the IRS and many tax authorities have categorized cryptocurrencies as property, the logical assumption is that NFTs (Non-Fungible Tokens) would be treated similarly for tax purposes, and you can therefore harvest losses by selling NFTs that have declined in value.
However, there are a few things to consider especially for NFTs, such as challenges with establishing a fair market value or finding buyers to sell your NFTs to.
What is the crypto tax-loss harvesting deadline?
You must sell the assets you want to harvest losses from before the end of the last date of the tax year to be eligible for claiming the loss on your tax return for the same financial year. If you are a US taxpayer and want to harvest losses for your 2023 tax return, you must realize the losses by December 31st, 2023.
Any transactions made after this date will be included in next year’s tax return, so it might be a good idea to add a calendar notification on or before December 31 each year for reviewing your tax-loss harvesting opportunities.
How to get started with tax-loss harvesting
The easiest way to get a complete overview of your tax-loss harvesting opportunities is to create a free Coinpanda account first.
After creating your account and confirming the settings for country and currency for tax calculations (typically the local currency in your country), you must import all transactions from the exchanges, services, and wallets you have used. Luckily, Coinpanda supports more than 800+ integrations with either API or by uploading CSV files, so importing your data is as easy as it gets!
After you have imported all transactions and Coinpanda has completed the required calculations, head over to the Dashboard to see a complete breakdown of your unrealized gains and losses. You can use this information to spot opportunities for harvesting losses and reducing your tax bill.
Before reporting cryptocurrency on your taxes, go to the Tax Reports page and download the reports you need. Coinpanda lets you export PDF and CSV reports for more than 65+ countries. You can export country-specific reports for countries such as the US, Canada, Australia, the UK, France, Japan, Ireland, and more.
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