Have you lost money on crypto or other financial assets? Do you want to save hundreds or even thousands of dollars on your taxes?
Tax loss harvesting is one of the easiest ways to reduce your tax bill. By selling losing positions and realizing losses, you can offset capital gains in other parts of your portfolio and up to $3,000 worth of income.
In this guide, we will look at how tax loss harvesting works and how you can use tax loss harvesting to save money on your taxes.
Tax loss harvesting can help you save big money on your tax bill by realizing losses to offset capital gains and up to $3,000 in ordinary income.
What is Tax Loss Harvesting?
The IRS taxes investment gains and allows you to deduct losses. But, you only pay taxes and take deductions when you realize those losses.
In other words, you have to sell the cryptocurrency before you owe anything. If you're still holding it in your portfolio, the gains or losses are unrealized and not subject to any tax treatment (yet).
When the market drops, it's common to have cryptocurrency with unrealized losses. These losses may be temporary if the market rebounds, but nothing stops you from selling the cryptocurrency to realize the loss. And you can immediately repurchase the cryptocurrency to avoid missing out on any rebound.
This practice is known as tax loss harvesting.
Let's look at an example:
Suppose that you invested $8,000 into Bitcoin (BTC). Currently, the position is worth $3,000. You still want to own BTC, so selling it outright doesn’t make much sense.
Since the Wash Sale Rule doesn’t apply to crypto transactions, you can sell your BTC and immediately buy it back. You have effectively captured a $5,000 capital loss that you can use to offset any capital gains or as much as $3,000 worth of income. And the best part is, you can carry forward any unused losses into future tax years!
Tax Loss Harvesting with Crypto
Tax loss harvesting isn't a crypto-specific strategy.
While many stock investors use the tactic, the IRS' Wash Sale Rule prevents them from realizing losses and immediately buying back the same stock. In particular, they prohibit you from deducting a loss if you repurchase the same security 30 days before or after the sale, making it a little more challenging to harvest tax losses.
Why don't these rules apply to cryptocurrencies?
The IRS states explicitly that the Wash Sale Rule only applies to securities. And according to past IRS guidance, cryptocurrencies are considered property, not securities. As a result, the Wash Sale Rule does not apply to cryptocurrencies. So, unlike stocks, you can immediately repurchase a cryptocurrency after realizing a loss and still deduct it.
Cryptocurrencies are also much more volatile than conventional stocks and bonds, making tax loss harvesting even more profitable. After all, there are more opportunities to experience short-term losses.
How to Harvest Your Tax Losses
Tax loss harvesting seems simple: You sell and repurchase a losing cryptocurrency position. But, of course, the devil is in the details.
The first step is identifying your purchase price – or cost basis. For example, you may have bought the same cryptocurrency at different prices. So, when you sell a cryptocurrency position, you must compute the cost basis to quantify your loss. And these calculations may depend on your accounting method and other factors.
When computing your cost basis, you must account for transactions across wallets and exchanges. For instance, if you use the first-in-first-out (FIFO) accounting method, you must determine the "first" cryptocurrency purchase between all your accounts.
The best way to accomplish this is to maintain a single ledger for all your accounts. Using ZenLedger or similar tools, you can aggregate transactions across all your accounts and instantly understand your cost basis. And we even provide a tax loss harvesting tool (above) that can help you automatically find opportunities.
At the end of the year, you report all capital gains and losses on Form 1040 Schedule D. If your capital losses exceed your capital gains, the amount of the excess loss can lower your income by the lesser of $3,000 ($1,500 if married filing separately) or your total net loss. And you can carry forward any unused losses into upcoming years.
ZenLedger simplifies this process by auto-populating Form 1040 Schedule D based on your transaction history. So, you don't have to worry about manually computing these figures or paying an accountant to spend hours pouring over your CSV exports.
It’s worth noting that resetting your cost basis with tax loss harvesting also resets your holding period. Long-term losses will be applied first to offset long-term gains. They are then applied to cover short-term gains. Then, any remaining amount can be applied to income up to $3,000.
If you repurchase coins that you harvested losses on, capital gains will be subject to short-term tax rates for 12 months before the rate drops when they are classified as long-term gains.
Frequently Asked Questions
Are there any tax loss harvesting limits?
You can offset your capital gains with harvested tax losses and up to $3,000 in income. If you cannot use all the tax savings, you can roll it forward to subsequent tax years.
How often should you harvest tax losses?
Many investors wait until year-end to harvest tax losses. But, of course, that's not an ideal strategy. You may have many opportunities to harvest tax losses throughout the year. And regularly taking advantage of these dips in the market can help you save a lot of money on taxes.
Are there any risks to keep in mind?
Realizing losses resets the clock on the position from a tax standpoint. While that's not a problem for long-term investors, it could influence whether you pay short-term or long-term capital gains tax.
In addition, tax loss harvesting rules could change for cryptocurrencies. Several proposed legislation aims to close the "loophole" for cryptocurrencies. And if passed, cryptocurrencies may be subject to the Wash Sale Rule or a similar rule.
Can you harvest losses from NFTs?
The IRS considers NFTs property like any other crypto asset, subject to the same laws. As a result, you can harvest tax losses by selling NFTs to realize a loss.
The Bottom Line
Tax loss harvesting is one of the easiest ways to save hundreds or thousands of dollars on your taxes. You can offset capital gains and up to $3,000 worth of income each year by realizing losses. And since cryptocurrencies are so volatile, there are many more opportunities to harvest tax losses than in the stock market.
If you want to start harvesting your tax losses, ZenLedger makes it easy to organize your transactions and find the best opportunities.