Start planning with our FREE 2024 Crypto Tax Playbook
Tax loss harvesting is a popular strategy used by investors to lower their tax bill by selling securities at a loss to offset capital gains. This technique can also be used with cryptocurrencies to realize crypto losses that can offset gains.
In this in-depth guide, we’ll cover everything you need to know about how crypto tax loss harvesting works, the rules and requirements, the potential benefits, and who can benefit from using this strategic tax move.
Cryptocurrency tax loss harvesting refers to the strategy of selling your digital currencies at a loss when the market value drops below your purchase price. This allows you to generate capital losses which can be used to offset capital gains realized when selling other cryptocurrencies at a profit.
Here is a formal definition of crypto tax loss harvesting:
Cryptocurrency tax loss harvesting is the strategic sale of crypto assets at a loss below the original cost basis to produce capital losses for the purpose of minimizing capital gains tax liabilities from profitable cryptocurrency sales. These generated losses are used to offset realized crypto capital gains.
This crypto tax strategy provides benefits by lowering an investor’s overall net capital gains that are exposed to capital gains taxes. This can reduce or even eliminate an individual’s tax burden from their profitable crypto transactions for the year.
The approach works the same way as tax-loss harvesting in stock investing and applies to cryptocurrency assets like Bitcoin, Ethereum, Solana, Cardano, and more.
Any cryptocurrency that is taxed by the IRS can qualify for crypto tax loss selling. This includes coins, tokens, stablecoins, DeFi governance tokens, and NFTs that meet the IRS classification guidelines.
Carrying out cryptocurrency tax loss harvesting involves several key steps:
Here is a simplified example to illustrate the crypto tax loss harvesting approach in action:
As shown in this example, Lucy was able to lower her tax liability by intentionally selling Ethereum to generate a loss which offsets her taxable crypto income.
Conducting cryptocurrency tax loss harvesting properly requires paying close attention to associated IRS rules and requirements:
Proper documentation becomes very important for demonstrating to the IRS that realized losses were in fact genuine if your crypto tax return is ever challenged or audited.
Conducting purposeful crypto tax loss selling offers several advantages for cryptocurrency investors and traders including:
The unique volatility of the crypto market compared to traditional assets gives investors an advantage in aggressively utilizing tax loss harvesting opportunities.
Consider the following scenario as an example case study for how crypto tax loss harvesting can play out in the real world:
Tom initially invested $10,000 into a portfolio of five different cryptocurrencies in January 2021 spread out as follows:
By December 2021, Tom’s crypto portfolio value sank significantly from the year’s highs, with losses across the board.
Tom decides to harvest his crypto tax losses before the end of the year by selling his losing positions to offset some capital gains he realized earlier from selling 1 BTC in February 2021 shortly after its peak above $50,000.
He initiates the following crypto tax loss sales on December 15, 2021:
Tom avoids selling his Bitcoin and Stellar to maintain his core holdings in those assets.
However, he does plan to wait at least 31 days before considering repurchasing the sold assets of LINK, LTC, and ETH.
By executing these tax loss harvest sales trades in December, Tom was able to realize a total of $20,000 in capital losses in 2021 as calculated below:
As a result, Tom can claim the full $20,000 capital loss amount on his 2021 taxes to offset his previous $15,000 gain from selling 1 BTC in February 2021 at a price of $55,000 when his cost basis was $9,000.
Harvesting these losses gave Tom peace of mind entering tax season knowing that he largely eliminated his 2021 crypto tax obligations and can carry forward the remaining unused $5,000 capital loss balance to apply in 2022 and beyond.
If the crypto market rebounds in early 2022, Tom also still has the option to rebuy the liquidated assets of LINK, LTC and ETH after waiting 31 days.
While crypto tax loss harvesting can produce substantial tax savings, some common concerns surrounding the strategy include:
As with any thoughtful tax planning strategy, the benefits of executing crypto tax loss harvesting judiciously will typically outweigh any associated hassles or expenses. But be sure to consider the pros and cons in your specific situation.
In summary, cryptocurrency traders and long-term HODLers with:
…are ideal candidates to benefit from proactively utilizing crypto tax loss harvesting now at year end or as a recurring tax reduction strategy.
Any crypto investor who finds themselves in a taxable net gain position can immediately lower their tax bill by intentionally realizing losses through crypto tax loss selling.
For instance, active crypto traders frequently cycling between trades can leverage periodic loss harvesting to minimize taxes owed. Even long-term buy-and-hold cryptocurrency investors holding assets acquired at lower cost basis can harvest sizable losses after large price declines.
Check your own crypto portfolio for tax loss harvesting opportunities before the end of the year. Selling losers at a loss while preserving your winners amplifies overall returns in the long run by letting you keep more profits in your pocket.
By understanding how to effectively conduct crypto tax loss harvesting and apply the harvested losses, individuals and businesses transacting in digital currencies can master this handy tool for reducing their cryptocurrency tax liabilities.
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