With crypto prices plunging in 2022, many investors are sitting on significant losses. But there is a silver lining – tax-loss harvesting. This strategy allows you to sell holdings at a loss to offset taxes on gains elsewhere in your portfolio. Read on for a complete guide on how crypto investors can utilize tax-loss harvesting to maximize returns.
The wild swings of the crypto market can lead to major losses – but also major tax savings if you harvest them properly. By selling cryptos and realizing losses before the end of the tax year, the capital losses can be used to offset capital gains from other investments or income. This directly reduces how much tax you owe. The key is being strategic with the timing of tax-loss harvesting and avoiding “wash sale” violations where you buy back the same asset too soon.
In this comprehensive guide, you’ll learn:
- What exactly crypto tax-loss harvesting is
- How the strategy works step-by-step
- What cryptos can be used and IRS limits
- Tax planning tips to maximize savings
- Examples of crypto tax-loss harvesting
- Risks and downsides to be aware of
- Top software to automate reporting
- When to enlist a tax professional
So buckle up as we dive into everything you need to know about tax-loss harvesting with Bitcoin and altcoins.
What is Tax-Loss Harvesting for Crypto Assets?
Before we get into the nitty gritty details, let’s start with the basics – what is tax-loss harvesting?
In simple terms, tax-loss harvesting is the practice of deliberately selling assets at a loss to offset capital gains tax. For crypto investors, it involves selling holdings like Bitcoin and Ethereum that have dropped below your purchase price to realize investment losses for tax purposes.
By doing this, the resulting capital losses can be used to offset capital gains from other investment gains or income. This directly reduces the amount of tax owed. It converts investment declines from unrealized losses (only on paper) into realized losses that provide actual tax savings.
Tax-loss harvesting provides two main benefits:
- Offsets taxes owed – Losses offset gains directly lowering total tax bill. Every $1 of loss can save $0.15 to $0.40+ in taxes depending on income level.
- Increases purchases power – The tax savings can then be reinvested to buy more crypto. As prices rebound, this enables faster recovery and portfolio growth.
It essentially takes lemons (crypto declines) and makes lemonade (tax savings). With the bear market continuing into 2023, tax-loss harvesting is a way to squeeze some value from the pain.
How Does Crypto Tax-Loss Harvesting Work?
Now that we’ve covered the basic definition, let’s walk through how crypto tax-loss harvesting works step-by-step with some simple examples:
- Purchase assets when prices are high – You first buy into a crypto position when asset values are elevated, like in late 2021. For example, 1 BTC purchased at $60,000.
- Asset values decline – Due to crypto market volatility, the value of your holdings drop over the following year. Your 1 BTC is now worth $16,000 with an unrealized loss of $44,000.
- Sell asset for a loss – Before December 31st, you sell the 1 BTC position for $16,000 realizing a capital loss of $44,000 for tax purposes in 2022.
- Offset capital gains/income – On your 2022 tax return, the $44,000 loss offsets $44,000 of capital gains from stock sales or other income that would have otherwise been taxed.
- Repurchase similar asset – After waiting 30 days, you re-enter your Bitcoin position buying 1 BTC again at the current lower value of $16,000.
That’s the basic 5 step process for executing a crypto tax-loss harvest. It allows you to benefit from downward price movements through significant tax savings.
Now let’s review a full numeric example:
- Mike purchased 0.2 BTC on October 15, 2021 when prices were $60,000 per BTC totaling $12,000.
- On December 1st, 2022 with BTC at $16,000, Mike sells his 0.2 BTC for $3,200 realizing a capital loss of $8,800.
- Mike has $10,000 of realized capital gains from stock investments in 2022.
- On his tax return, the $8,800 BTC loss offsets $8,800 of the $10,000 gains.
- Instead of owing taxes on $10,000 of gains, taxes are now only owed on the remaining $1,200.
- After waiting 30 days Mike rebuys 0.2 BTC for $3,200 as he still believes in crypto’s long term trajectory.
By tax-loss harvesting, Mike transformed a paper crypto loss of $8,800 into real tax savings of approx. $1,300 to $3,300 depending on his tax bracket. This value can then be redeployed back into crypto at lower prices enhancing position value as the market eventually recovers.
The steps are straightforward in theory but do require some careful planning as we’ll explore later.
Virtually all cryptocurrencies can be used for tax-loss harvesting – Bitcoin, Ethereum, and altcoins. Per IRS guidance, crypto is treated as property similar to stocks in terms of capital gains and losses tax treatment.
So whether you are sitting on losses in blue chip assets like BTC and ETH or smaller altcoins, they all qualify provided you meet a few requirements:
- You actually complete the sale and realize losses before December 31st – unrealized paper losses don’t count.
- You’ve held the asset for over a year – short term capital losses have different rules.
- The losses don’t violate the wash sale rule meaning you don’t buy back the same asset within 30 days.
Additionally, crypto losses first offset other capital gains. Any amount remaining can be used to offset up to $3,000 of ordinary income. Excess losses beyond $3,000 can be carried forward to future tax years.
So virtually all types of crypto assets in your portfolio are fair game for tax-loss harvesting. Review your full holdings for declining coins bought over a year ago to identify loss harvesting opportunities and avoid letting them go to waste.
What Are the Rules and Limits on Crypto Tax-Loss Harvesting?
While the concept is straightforward, there are some key rules and limitations to keep in mind:
Wash sale rule – You cannot buy back the “same or substantially identical” crypto asset within 30 days before or after the sale without triggering a wash sale violation. This disqualifies the capital loss.
Long term holding period – For losses to qualify as long term capital losses, you must hold crypto for over a year before selling.
Offset limits – You can only use $3,000 of total capital losses to offset ordinary income in one year. Remaining capital losses carry forward.
Netting losses – Short term gains and losses are netted separately from long term. You cannot net short term losses against long term gains.
So while the core concepts are simple, savvy tax planning is vital maximize loss harvesting benefits. Strictly follow the 30-day waiting period before repurchasing assets and beware of short term vs long term capital loss differences.
Now let’s get into the step-by-step process for executing crypto tax-loss harvesting transactions.
Step-by-Step Guide to Tax-Loss Harvesting Cryptocurrency
Here is a detailed walkthrough for carrying out crypto tax-loss harvesting to maximize benefits:
1. Track Your Cost Basis in All Holdings
First, take inventory of your entire crypto portfolio and accurately track the purchase date and cost basis of each coin holding. This establishes your loss levels compared to current values.
Cryptocurrency tax software can greatly help track basis across wallets and exchanges. More on software later.
2. Identify Position with Realized and Unrealized Losses
Next, scan your holdings for assets trading below your cost basis with current unrealized losses. Also assess assets you already sold in the current tax year at a loss which have realized losses. Both types qualify for harvesting.
3. Execute Sale Transactions of Loss-Making Assets
Once suitable positions with losses are identified, execute market sell orders for enough of the holdings to produce your target level of realized capital losses. $10,000 or $20,000 increments work well depending on your tax situation.
For most effective tax reduction, take losses by December 15th allowing time for transfers or withdrawals from exchanges before year-end. Know an exchange’s settlement timeline when assessing end-of-year cutoffs.
4. Wait 30+ Days Then Repurchase Similar Crypto Assets
This is critical to avoid violating wash sale rules. Do not buy back the same crypto coins within 30 days before or after the sale date.
After 31+ days you can re-enter similar crypto positions if still confident in their outlook. Use the interim to reassess market conditions first.
Maximizing Tax Savings with Proper Loss Harvesting Planning
Executing the basic four steps above can produce substantial tax savings. However, more advanced planning around loss harvesting can multiply benefits even further:
Time Sales Strategically Around Market Cycles
Harvest losses when market prices plunge to extremely attractive levels you expect could reverse higher later. Coin prices often bounce significantly intra-year presenting prime rebuying opportunities if timed well.
Take Losses Before Year End
Selling for a loss by December 15th provides buffer to complete transfers off exchanges when needed. Realized losses only count for deducting that tax year’s capital gains/income.
Avoid Wash Sales from Overeager Repurchasing
Strictly follow the 30-day rule before repurchasing same coins or substantially identical altcoins which the IRS could deem violations resulting in loss disqualification.
With the right tax-savvy crypto loss harvesting approach, investors can significantly cut their coin tax bills and turbocharge portfolio rebounds when the bear market eventually transitions back into a bull run.
Tax-Loss Harvesting Strategies and Examples
Let’s review some examples of effective crypto tax-loss harvesting scenarios to reduce taxes owed while sticking to IRS rules:
Rotate between similar altcoins – Rather than repurchasing the same altcoin, rotate into similar but distinct alternatives. For example, selling ADA for a loss then buying DOT after 30+ days.
Swap stablecoins briefly – Park proceeds in stablecoins as an interim step before reinvesting in desired crypto. This avoids buying anything substantially similar for 30 days.
Harvest Bitcoin then diversify – Realize BTC losses then diversify into varied altcoins as price points for rotation. Wait before re-upping Bitcoin exposure.
Layer tax-loss harvesting – Harvest smaller loss tranches at market swoons through the year vs. just year-end. Lengthens reinvestment runway.
Offset short term gains first – If you have both short and long term gains, harvest short term losses which directly avoid higher ordinary income tax rates.
Savvy crypto investors don’t just hodl assets in a downtrend. They strategically tax-loss harvest declining holdings to maximize wealth protection and portfolio performance.
Key Risks and Downsides to Cryptocurrency Tax-Loss Harvesting
While this guide has focused heavily on the benefits of crypto tax-loss harvesting, there are some notable risks and downsides to consider before jumping in:
Market timing challenges – It can be difficult to identify clear market bottoms and reentry points. Prematurely selling holdings low then buying back higher creates a loss on loss.
High volatility – Cryptocurrencies can reverse rapidly. A quick rebound after selling could force repurchasing at significant price premiums.
Trading fees – Exchanges charge trading fees that diminish portfolio value, especially if positions are traded more actively. Fees add up incrementally with tax-loss harvesting.
Wash sale penalties – As covered earlier, violating wash sale rules results in loss deductions getting denied by the IRS. This causes loss harvesting attempts to backfire. Carefully manage wash sale compliance.
Tax software costs – Quality cryptocurrency-savvy tax prep software has an expense to accurately handle tax-loss harvesting trades and prepare required forms.
For these reasons, consult with a knowledgeable crypto tax professional before employing aggressive harvesting strategies. Tax guidance can help maneuver tricky scenarios, but every crypto investor can benefit from at least basic tax-loss harvesting techniques.
Crypto Tax Software to Automate Reporting After Harvesting Losses
Cryptocurrency transaction tracking is challenging itself without adding intricate tax-loss harvesting trade activity on top. As a result, crypto-focused tax software is almost essential to effectively report tax-loss harvesting while avoiding headaches.
Here are three top crypto tax solutions:
Cointracker.io – Top rated platform supporting 400+ exchanges. Auto-generated tax reports. Free import and loss harvesting tools.
Koinly.io – Wide format compatibility. Capital gains, income and mining reporting. Free plan available.
CryptoTrader.tax – Tax loss harvesting and tax planning tools. DIY or full advisory packages. Integrates with TurboTax.
Quality software automates the intricacies of classifying and accurately reporting each crypto-related transaction across wallets and exchanges. This prevents critical mistakes when managing extensive tax-loss harvesting alongside normal trading activity.
Investing in capable tax reporting technology also frees up time and energy to focus on executing sound crypto investment and tax-reduction strategies rather than paperwork.
Consult a Tax Professional When Needed
Even with the very best tax software, certain complex crypto activities like aggressive loss harvesting may warrant consulting tax professionals.
Here are two instances when seeking tax help can be beneficial:
- Unclear or borderline wash sales – If fuzzy on whether certain loss harvest trades violate wash sale rules, tax pros provide informed guidance.
- Other substantial capital transactions – In years with intensive investing activity, real estate transactions etc, an advisor assesses holistic tax minimization tactics.
Reputable tax experts keep sharp on the latest in cryptocurrency tax nuances and evolving IRS guidance in order to best structure major transactions. Their input helps investors confidently reap the fullest benefits from crypto tax-loss harvesting opportunities in the tricky current environment.
Conclusion – Time Your Crypto Losses to Lower Your Taxes
With cryptocurrencies in an extended bear market entering 2023, investors are sitting on mountains of losses. Through tax-loss harvesting, these losses can be strategically converted into direct tax savings to retain more portfolio value.
Selling depreciated coin positions by the end of the tax year allows for capital losses to offset capital gains or income that would otherwise generate a tax burden. After a 30 day waiting period, investors can reestablish desired crypto holdings at lower cost basis to capture future appreciation tax-free.
This guides provided a soup to nuts walkthrough of implementing crypto tax-loss harvesting including working through examples. We also covered key rules and limitations around wash sales and loss limits as well as top tax software to streamline reporting.
While proper tax-loss harvesting does require some planning, attention and software costs, the tax alpha generated typically outweighs any friction by an order of magnitude.
Every crypto investor should assess their holdings for opportunistic loss harvesting plays. Don’t squander losses for nothing. Transform them into wealth preservation today by keeping more gains and powering a faster portfolio rebound tomorrow. Timed properly, tax-loss harvesting can convert portfolio lemons into refreshing lemonade even amidst crypto winter!