The cryptocurrency industry is widely considered to be still in its nascent stages. Crypto markets can be pretty volatile as a result, cyclically registering steep highs and lows.
In 2022, for example, the top two crypto assets by market cap—Bitcoin (BTC) and Ethereum (ETH)—dropped nearly 75% below their respective all-time highs of $68,990 and $4,891. Most other cryptocurrencies performed poorly as well this year, due to various internal and external factors.
Nevertheless, it might be possible to take some sting out of market downturns like these using crypto tax-loss harvesting.
Generally, tax-loss harvesting, aka tax-loss selling, is the practice of strategically realizing capital losses on your investments and using them to offset capital gains or ordinary taxable income. It’s possible with instruments classified as ‘assets’ or ‘property’ by the concerned authorities.
Since most cryptocurrencies currently belong to the above categories as per U.S. laws, taxpayers can apply tax-loss harvesting strategies to crypto assets.
This may help them reduce their annual tax bill in 2022.
What is the significance of tax-loss harvesting?
Tax-loss harvesting can be particularly significant for taxpayers with massive tax liabilities. This may apply to entities with high capital gains or ordinary income, as well as those residing in jurisdictions with high tax rates.
Similarly, however, even individuals with medium or low taxable income can also reduce their income tax liability using tax-loss harvesting.
Moreover, tax-savvy investors may consider tax-loss harvesting as a viable means of turning losses into gains. This can help them retain more value in their portfolio at the end of each tax year, enhancing their long-term capital accumulation.
Thus, given compliance with the existing tax code, tax-loss harvesting can provide a legal way of reaping tax benefits.
How does tax-loss harvesting work for crypto assets?
U.S. taxpayers can tax-loss harvest for cryptocurrencies, similarly as they would for traditional financial assets like stocks, funds, or ETFs. This means you can possibly offset capital gains across your portfolio—not just digital assets—using losses realized in crypto assets.
Suppose you purchased EXAMPLE coins for $1000 in, say, May 2022. Now, let’s say the asset’s price drops to $700 in December, while you’re still holding the bag. So, by selling your EXAMPLE coins at the current price, you can realize a capital loss of $300.
Deliberately making a loss may appear stupid. But not so much with possibilities like crypto tax-loss harvesting. You can use the $300 loss to offset capital gains of, say, $5000. Thus, your taxable capital gains for the current year will be $4700, not $5000. And with net capital gains tax rates ranging from 15% to 28% in the US, this could amount to significant savings.
Similarly, you can also use crypto capital losses to offset your ordinary income up to $3000 annually. There’s also the option to carry forward capital losses greater than $3000 into future years, indefinitely till it’s balanced out. So, if the net crypto capital loss is $9000, for instance, you can offset $3000 from your ordinary income each year for three years.
Furthermore, it’s possible to harvest crypto tax-loss despite successfully holding assets you believe in for the long-term. This is because the U.S. Internal Revenue Service (IRS) wash sale rule doesn’t apply to cryptocurrencies currently. Thus, unlike ‘securities’ like stocks, you can repurchase your crypto asset holdings after selling them to realize a loss.
Note
It’s anyway better to be mindful of the various nitty-gritties regarding the crypto wash sale rule, ensuring precautionary compliance while planning crypto taxes.
U.S. income tax brackets (2022)
Note that these are the same as your short-term gain tax rates.
U.S. long-term capital gains tax rates (2022)
Besides factoring short-term and long-term crypto gains separately, your tax-loss harvesting strategy may also consider crypto investments’ varying price points. This can be very significant, since crypto markets often have massive volatility.
To illustrate, suppose you bought two EXAMPLE coins in January and May, 2022, for $1000 and $1500, respectively. Now, let’s say you decide to harvest the tax-loss on one of these coins by selling it at $800 in November. So you can either realize a loss of $200 on the first coin or $700 on the second coin. However, such choices may get increasingly confusing when there are many price points.
The choice depends upon your tax reporting strategy. Commonly, there can be three possible approaches here: First-In-First-Out (FIFO), Last-In-First-Out (LIFO), and Highest-In-First-Out (HIFO). FIFO is usually the common approach, where you may sell the coins in the chronological order of their purchase. So the coin bought in January is sold first. LIFO, understandably, is the opposite.
HIFO, on the other hand, requires you to first sell the coin with the highest cost basis, i.e., the purchase price plus fees.
In our example this overlaps with LIFO, but it may not be necessarily so.
Pro Tip
Building an effective tax reporting strategy can get highly complicated, involving various broad and subtle aspects. It’s thus advisable to consult expert tax professionals for this purpose.
How to get started with crypto tax-loss harvesting?
Once you have a robust tax reporting and savings strategy in place, you may begin harvesting tax-losses on your crypto assets. Depending on your strategy, you can harvest crypto capital losses throughout the year, during steep dips in the crypto market, or at the year-end.
One possible benefit of harvesting losses shortly before filing tax returns is having a clearer approximation of the capital gains. There’s no hard and fast rule for this. But you must report harvested tax-losses in the current year, otherwise you may not be able to offset them anymore.
Besides the strategy, having a comprehensive overview of your entire investment portfolio can help significantly with tax-loss harvesting. Public’s holistic investing platform provides such seamless access to all your financial assets—stocks, funds, and crypto—in a single place. We also offer an intuitive and easy-to-use mobile app for a superior user experience.
Our ‘Instant Withdrawal’ and ‘Instant Deposit’ features enable you to quickly move funds while buying or selling digital assets. Moreover, Public has minimal fees. These features can improve your chances of grabbing tax-loss harvesting opportunities, without the costs eating into your tax savings.
Recurring Investments can also help ensure wash sale rule compliance while repurchasing long-term crypto holdings after harvesting them for tax-loss. You’re less likely to commit a wash sale by re-entering your crypto positions gradually, rather than abruptly.
Furthermore, Public Premium unlocks an even greater range of features, such as custom price alerts, live price charts, and institutional-grade research. You can thus monitor your loss-making assets closely, harvesting losses at the right time for optimal tax savings.
Our Transfer Account feature is also available, so you can easily move your investments to Public. There’s no transfer fees, plus you get a superior crypto tax-loss harvesting experience this year-end. So join us now at Public.
Frequently Asked Questions
Is tax-loss harvesting a form of tax evasion?
No, tax-loss harvesting is perfectly legal as long you’re doing it in compliance with the current tax code. This means you have to report all gains and losses properly, and maintain whatever records may be necessary.
What are the tax rules on crypto?
Cryptocurrencies are taxed similarly as other financial ‘assets’ or ‘property’ per the definitions provided by U.S. authorities. You can refer to the IRS’s FAQs on Virtual Currency Transactions for more details on this topic.
How do I record crypto losses for tax purposes?
You can easily maintain transaction records and access your complete transaction history while investing in crypto assets on Public. You can also get balance sheets and reports, which further eases tax reporting.
Does the wash sale rule apply to cryptocurrency?
The IRS applies the wash sale rule only to ‘securities’ as of December 2022. Since cryptocurrencies are classified as ‘property’ or assets, the wash sale rule doesn’t apply to crypto transactions. However, this may change in the future.
How do I tax-loss harvest NFTs?
Since ordinary cryptocurrencies and NFTs are the same from a tax reporting point of view, you can harvest tax-loss on NFTs just like you would for any other crypto asset in your portfolio.
