The crypto markets had a volatile 2020, andthat might mean you lost money on your cryptocurrencies. Here's everything youneed to know about how you can offset your crypto losses by putting tax-lossharvesting to work.
What is Crypto Tax Loss Harvesting?
Tax-loss harvesting is a tax strategy whereyou sell an asset for a loss and lower your taxes. These losses can offsetcapital gains incurred during the year and up to $3,000 of ordinary income tax.If your losses exceed $3,000 and any capital gains for the year, you can rollthe losses forward to future years and offset those gains.
For example, suppose that you bought coins at$10,000 in February 2021 and you're still holding it at $7,000 today, whichrepresents a 30% unrealized loss. You could harvest the loss by selling coinsto realize the $3,000 loss and use that $3,000 to offset other taxes that youowe this year or carry those losses forward to next year.
Of course, the IRS wants everyone to pay theirfair share of taxes, so they introduced the Wash Sale Rule to prevent investors from incurring losses andrepurchasing the same security within 30 days. While these rules apply tostocks, the IRS considers cryptocurrencies property, rather than securities, sothe rules do not apply to crypto investors.
A Note for Beginners:
What is Meant by Offsetting Taxes?
It is aterm used to describe balancing the money that you owe with the money you areowed. Say, your tax returns show a refund from the IRS. That is the money youare owed along with that you have prior tax debts. The IRS can keep all or someof your tax refunds to pay those tax debts. Tax loss harvesting crypto hugelyrevolves around offsetting taxes. You may call the toll-free number, (800)304-3107, provided by the IRS to see if you have any offsets against yoursocial security number.
What is a Wash Sale in Crypto?
The WashSale rule states that if you cannot buy back an investment in which youincurred a loss before or after 30 days of selling it. You need to get rid ofthe investment for a month to obtain the loss. The concept of a wash sale isapplied by investors to create an artificial loss. They sell an asset for aloss and buy back the same when the price is low before the dynamic marketchanges again. This saves them from claiming a capital loss.
The US WashSale rule applies to securities such as bonds and stocks but crypto isconsidered property by the IRS. This means the US Wash Sale rule doesn't applyto bitcoin or other cryptocurrencies.
What is The Same Day Rule?
This ruleis similar to the Wash Sale rule for creating artificial losses. Developed bythe HMRC, it states that if you buy or sell the same crypto withina day your cost basis will be the price you paid to buy the coins. The previouscost basis won't count and you cannot create an artificial loss.
What is The Bed and Breakfast Rule?
The bed andbreakfast rule says crypto holders can buy or sell their crypto within 30 daysat a cost basis based on the purchase price of the 30-day time frame. Thisprevents the creation of artificial losses.
When to Harvest Your CryptoLosses?
Most tax-loss harvesting occurs at the end ofthe year before the December 31st deadline. That way, you can realize anylosses and use them to offset taxes in the current year. The only exceptionsoccur when there's a large market movement that creates potentially temporarylosses, such as the COVID-19 crisis or the Great Recession in 2008 and 2009.
Since the Wash Sale Rule doesn't apply tocrypto, you can easily harvest tax losses throughout the year without worryingabout finding the right portfolio replacements or throwing off your assetallocations. You are effectively generating tax deductions in the current yearand delaying the payment of any capital gains for future years.
The biggest drawback to tax loss harvesting crypto isthat you must pay the transaction costs associated with each trade. Dependingon how you buy and sell crypto, these fees could include maker/taker fees,transaction fees, or bid/ask spread differences. The good news is that thesefees tend to be less than the equity markets, making the strategy morefeasible.
Does Crypto Tax Loss Harvesting Apply to Me?
Do you have gains from other investments thisyear (like stocks) that you’ll need to pay taxes on for your 2023 return? Ifso, you can use losses from crypto for a tax win, by offsetting any gains youhad in other positions and/or offset even ordinary income. You will most likelywant to REALIZE enough capital losses in crypto to OFFSET your capital gains instocks or other places. You can also often use up to $3,000 in capital lossestowards the income you earned.
The Deadline is December 31st
Don’t delay! The deadline for realizing losseson your crypto is DECEMBER 31st. Youwill need to sell your crypto at a loss within the calendar year if you want toharvest those losses to offset other gains you will have to pay the IRS thisyear.
How to Harvest Your CryptoLosses?
The firststep in harvesting tax losses is identifying the capital gain or loss foreach position in your portfolio by subtracting the current price from the costbasis. It's important to keep in mind that you must consider all of your cryptoholdings — not just those in the same wallet or on the same exchange — whencalculating capital gains and losses.
The cost basis is influenced by the accountingmethod that you use — FIFO or LIFO:
- First-in-First-Out (FIFO)
- Last-in-First-Out (LIFO)
Traders using the FIFO method calculatecapital gains or losses using the difference between the price of the sale andthe earliest buy price, i.e.,
Sale price- earliest buy price = capital gains or losses
Traders using the LIFO method calculatecapital gains or losses using the difference between the price of the sale andthe most recent buy price, i.e.,
Sale price- recent buy price = capital gains or losses
FIFO is usually the preferred method becauseit minimizes the risk of short-term capital gains. In particular, you'reselling the oldest positions first, which means that you're more likely torealize a long-term capital gain. It's a good idea to talk to your accountantto learn more about the right accounting method for your situation.
The finalstep in crypto tax lossharvesting is simply selling the position for a loss, andoptionally, repurchasing the position to maintain the portfolio's assetallocation. Of course, it’s important to make those moves in conjunction withyour wider financial situation — the capital losses realized fromcryptocurrencies can offset losses in stocks and other areas.
How to Use ZenLedger's Crypto Tax Loss Harvesting Toolin 3 Easy Steps
Our tax-loss harvesting tool lets you know thecapital losses you have in each token you hold. Once you preview, you candecide to realize the loss by selecting a specific token and the amount.
Step 1: Launch The Tool
After you upload your transactions, you’ll seea menu item called Tax-Loss Harvesting on your dashboard. Click on this linkand we will begin to run our tool. It will take about 15 seconds to process.
Step 2: Read The Results
The output of our tool is a Google spreadsheetthat will open in a new tab of your browser. Each tab represents yourunrealized capital loss.
The first two tabs are summaries of your totalpotential losses to harvest, organized by currency. You can toggle betweenLIFO, FIFO, and HIFO accounting methods in the spreadsheet. We take a deeperlook at LIFO and HIFO below.
Tab 1: Summary By FIFO
This tab summarizes your losses as accrued byusing the FIFO accounting method (more widely recommended by tax experts). Pleasenote that you must be consistent year to year and between your tax-lossharvesting and your reporting on your 8949 or Schedule D. You cannot switchbetween these, you have to choose one and stick with it.
Tab 2: Summary By LIFO
This tab summarizes your losses as accrued byusing the LIFO accounting method. Please note that you must be consistent yearto year and between your tax-loss harvesting and your reporting on your 8949 orSchedule D. You cannot switch between these, you have to choose one and stickwith it.
Tab 4: FIFO Ordering of Sells
This table shows you all of the coins youcurrently own that have an unrealized loss using the FIFO accounting method.This is the raw data we use to create your summaries on tabs 1 and 2.
Tab 5: LIFO Ordering of Sells
This table shows you all of the coins youcurrently own that have an unrealized loss using the LIFO accounting method.This is the raw data we use to create your summaries on tabs 1 and 2. Choosethis if you want to realize all of your capital losses in crypto, or justenough to offset your non-crypto capital gains and $3,000 in income taxes.
Step 3: Realize Losses BySelling Your Crypto
Once you see where you have losses to harvest,it’s up to you to take action: Share this data with your tax professional sothe two of you can decide on the best approach, or log in to your exchange(s)and sell your coin(s).
What are The Risks of Tax Loss Harvesting Crypto?
There are two primary risks of crypto tax loss harvesting:
- Costs greater than savings: The costs you will incur to harvest the losses may outweigh the savings on your tax bill. For instance, you might have to pay as much as 4% in transaction fees when buying and selling through certain exchanges.
- Capital gains are only postponed: While tax-loss harvesting defers your capital gains, it doesn’t eliminate them permanently.
Your new cost basis will be equal to the fairmarket value (FMV) during the previous sale when you harvest your losses anduse the proceeds to purchase a replacement cryptocurrency (whether or not it’sthe same asset). Your new cost basis will be lower than your original costbasis. That implies that you’re possibly setting yourself up for an even largercapital gain if you sell the new asset at a profit in the future.
One of the common questions is whether or notthere is any risk of the wash sale rules applying to crypto. Now, wash salerules apply only to securities andstocks, not cryptocurrency.
Other Crypto Tax Tips
Harvestabletax losses in crypto are a greatway to reduce your tax exposure, but it's not the only tax strategy. There aremany different ways you can minimize your tax burden through careful planningwithout making any changes to your actual portfolio, as well as other ways tocapitalize on unique tax rules, such as those covering donations.
Short vs. Long-Term CapitalGains
You should always try to sell long-term cryptopositions held for more than a year since they generally have lower tax ratesthan short-term positions held for less than a year. In addition to capitalgain tax rates, you may be subject to an additional 3.8% Net Investment IncomeTax or other taxes at certain income levels.
Sell to Dollars vs. Crypto
You should try to set aside U.S. dollars tocover taxes after selling a crypto position for a profit rather than convertingpurely to another cryptocurrency. That way, you can pay your taxes for the yearwith those dollars on hand and don’t have to sell short-term crypto at high taxrates. The same goes for proceeds from a fork or other transaction.
Maintain Detailed Records
Keep a record of all of your cryptotransactions if you're not using an exchange that provides automated year-endtax statements. The process only takes a few minutes if you're using wallets orexchanges that support the ability to export transactions, but it can save youa lot of headaches when tax season rolls around if you’re not using crypto tax software.
Donating Crypto Assets
Donations are a great way to support a causewhile saving money on your taxes. If you itemize your taxes, you can take adeduction for these donations on Schedule A of Form 1040. The amount of thededuction depends on the holding period of the crypto asset—either the fairmarket value or the cost basis. However, if you don’t itemize, you cannotdeduct them.
The Bottom Line
The ZenLedger crypto tax-loss harvesting tool tells you what coinshave unrealized losses, but we do not direct you to an exchange or wallet tosell from. This is because all your coins are in the same “accounting” bucket.
Want to try out our tax-loss harvesting tool?Click the button below to create an account.