If the price of your cryptocurrency has plummeted, there may be a silver lining that can save you thousands of dollars on your tax bill: tax-loss harvesting.
In this guide, we’ll break down what tax loss harvesting is, explain why cryptocurrency is an unusually effective candidate for taking advantage of it, and walk through a step-by-step process to help you identify the best candidates for tax savings in your crypto portfolio.
What is tax-loss harvesting?
If you sell your stocks, real estate assets, or cryptocurrencies at a profit, you’ll be required to pay capital gains tax based on how much money you’ve made from the sale.
Some investors choose to reduce their capital gains in a given tax year by selling some of their assets at a loss. This is called
tax-loss harvesting. VIDEO How tax-loss harvesting works
Tax-loss harvesting is a very common strategy in the world of stocks and securities. To get a better understanding of how it works, let’s look at an example.
Without Tax Loss Harvesting
Here’s how much John incurs in capital gains if he decides
not to take advantage of tax-loss harvesting. With Tax Loss Harvesting
Here’s how much John incurs in capital gains if he realizes his losses on his Tesla stock.
Tax-loss harvesting with cryptocurrencies
Just like stocks, cryptocurrencies can be used for tax-loss harvesting. This means that you can also strategically sell/trade crypto to harvest losses and reduce your tax liability.
Unlike stocks however, cryptocurrencies have unique characteristics that make them
even better candidates for tax-loss harvesting. Let’s go through some of these advantages. Does the wash sale rule apply to cryptocurrency?
Right now, the IRS has a ‘wash rule’ in place that’s designed to prevent investors from taking capital losses and then immediately buying back the same stock. Incurring a capital loss on a stock is
not allowed if you buy the same security 30 days before or after the sale.
that wash sale rules only apply to securities. Cryptocurrencies are property, not securities, as defined by IRS specifically states . This means that as of now, wash sales rules do IRS guidance not apply to cryptocurrencies—however, this could change in the future. Volatility and tax loss harvesting
Cryptocurrencies are extremely volatile—more so than traditional assets. This volatility means that crypto investors have more opportunities to realize and harvest capital losses.
The difficult part for investors is identifying which of the cryptocurrencies in their portfolio have the highest
cost basis (original purchase price) when compared to the current market price. These are the assets that present the greatest opportunity for tax savings.
At the end of this article, we’ll share a step-by-step strategy for identifying tax-loss harvesting opportunities. Before jumping into that, let’s share a few tips for investors looking to harvest their capital losses.
Is there a limit to tax-loss harvesting?
Whenever total capital gains and losses for the year add up to a negative number, a net capital loss is incurred. If the net capital loss is less than or equal to $3,000 ($1,500 if you are married and filing a separate tax return), then that entire capital loss can be used to offset other types of income—like the income from your job.
Net losses exceeding $3,000 are rolled forward to subsequent years.
How often should I harvest my losses?
Many investors choose to wait until the end of the tax year to identify tax-loss harvesting opportunities and minimize their capital gains.
This strategy is
Because cryptocurrencies are so volatile, investors often have multiple opportunities to take advantage of tax-loss harvesting over the course of a year. Regularly taking advantage of these price dips can help investors save money and reduce stress at the end of a tax year.
What are the risks of tax-loss harvesting?
If you find yourself in one of these scenarios, tax-loss harvesting may not be right for you.
You are planning to liquidate your holdings soon: Be cautious of tax-loss harvesting if you are planning to sell off cryptocurrency you've purchased within the past 12 months. If you do sell your tokens, you will need to pay the short-term capital gains rate (10-37%) rather than paying the long-term capital gains rate (0-20%), which may apply if you’ve held your tokens for longer than 12 months. Your tax savings do not cover exchange fees: Before pursuing a tax-loss harvesting strategy, it’s important to consider exchange fees. It’s possible that the price to sell and rebuy your tokens is higher than your potential tax savings. Your long-term capital gains are already 0: If you’re single and making under $40,000 or married and making under $80,000, your long-term capital gains tax rate is already 0%. While tax-loss harvesting will not reduce your long-term capital gains tax, it can still offset your short-term gains and up to $3000 of income. Can I do tax-loss harvesting with NFTs?
At this time, NFTs are considered a type of crypto-asset, and are generally subject to similar tax rules as cryptocurrencies.
Similar to cryptocurrencies, you incur capital losses when you sell NFTs at a loss. In addition, it’s reasonable to assume that at this time, the wash sale rule does not apply to NFTs.
CoinLedger can help you identify your
opportunities. Just plug in your Ethereum wallet and let the platform take care of the rest. NFT tax-loss harvesting What if I bought my crypto at multiple price points?
Consider the following question in the infographic below.
The answer to the infographic above depends on what accounting method Brian chooses to use for his crypto transactions. In the United States, investors typically use the first-in first-out (FIFO) accounting method to calculate their crypto gains and losses. This accounting method sells off your coins in the order you received them.
Other accounting methods such as last-in first-out (LIFO) or highest-in first-out (HIFO) also exist. These methods require investors to be able to specifically identify the cryptocurrency that they’re selling.
To learn more about how each of these accounting methods works, check out our complete guide to
. FIFO, HIFO, and LIFO How can I get started with tax-loss harvesting?
If you’re using multiple wallets and exchanges, it can be difficult to keep track of the cost basis for each one of your assets. That means it can be difficult to identify tax-loss harvesting opportunities.
CoinLedger can help. The platform allows you to find all your tax-loss harvesting opportunities in minutes.
Let’s walk through the process.
1. Connect wallets and exchanges: Import your transactions from exchanges and wallets automatically or through a spreadsheet.
2. Generate your tax report: Once you’ve recorded all of your transactions, you’ll be able to generate a tax report with the click of a button.
3. Navigate to the tax-loss harvesting tab: Here, you’ll be able to see all your tax-loss harvesting opportunities. The list is sorted by how large your opportunity is. The report compares your cost basis for tax-loss harvesting with the current market price.
See how much tax-loss harvesting reduces your tax bill.
Once you know which cryptocurrencies present the best tax savings opportunities, you can sell or trade them on your exchange of choice.
Then, import the transaction(s) into CoinLedger and re-run your tax reports! You will then be able to see how much harvesting that loss reduced your net gains.
Frequently Asked Questions
Let’s summarize this article by answering a few frequently asked questions about cryptocurrency tax-loss harvesting.
Does the wash sale rule apply to cryptocurrency?
Based on current IRS guidance, it’s reasonable to assume that the
wash sale rule does not apply to cryptocurrency. Can I use LIFO for cryptocurrency?
The IRS allows investors to use LIFO if they are able to specifically identify their tokens. For more information, check out the
. IRS FAQ on crypto Is there a limit to tax-loss harvesting?
Tax-loss harvesting can be used to offset 100% of capital gains for the year and up to $3000 of personal income. Any net losses above this can be rolled over into future tax years.
Is tax-loss harvesting a form of tax evasion? No. Tax-loss harvesting is a common strategy that can help investors reduce their tax liability. Tax evasion is considered a criminal act and often occurs when taxpayers make false claims on their tax returns. What’s the deadline for tax-loss harvesting?
It is important to keep in mind that in the U.S. the tax year ends on Dec. 31st—even though the filing deadline isn’t until April 15th. If you want to claim losses this tax year, you’ll need to take action before New Year’s Day.
Many investors delay only to realize that they could have saved money on their tax bill if they would have sold or realized losses back in December. By that point, it’s too late for them to take advantage of tax-loss harvesting.
Don’t let this happen to you! You can see all of your tax-loss harvesting opportunities by creating a
with CoinLedger today. There’s no need to enter your credit card information until you’re ready to file your return. free tax report
To learn more about how cryptocurrency taxes work, checkout our
. Ultimate Crypto Tax Guide Disclaimer: This guide is provided for informational purposes only. It is not intended to substitute tax, audit, accounting, investment, financial, nor legal advice.