Should You Be Harvesting Your Crypto Tax Losses?
At the end of each year, investors have to decide whether it is best to hold onto an investment or if they should sell them off by December 31st. Choosing to hold or sell investments at year’s end comes down to whether or not the investor deems it more profitable to realize a gain or loss in the current tax year or wait and see what happens the following year.
This strategy is especially applicable for cryptocurrency investors, as realizing a loss this year can offset your tax liabilities when it comes to filing, and you can still reinvest the money you pull out, assuming the price point is right when you’re ready to jump back in.
What Is Tax-Loss Harvesting?
The United States Internal Revenue Code requires individuals to pay taxes on their gross income. Gross income includes almost all financial gains received during the taxable year (January 1 - December 31). Those with investments generally don’t realize again until they sell the investment, meaning they are only taxed on the investment in the year they sell it. This applies to most cryptocurrency holdings, specifically in which a person purchases for a set amount, hoping that the value of the purchased cryptocurrency continues to go up, leading to a profit when they eventually sell.
For those whose cryptocurrency holdings have dipped instead of grown, however, it may be advantageous to sell them before year’s end so that you can claim a loss, which in turn can be used as a deduction on your taxes. Put simply, “Tax-Loss Harvesting” is the act of selling investment and claiming a loss deduction.
Here’s an example of cryptocurrency tax-loss harvesting:
Suppose you purchased $15,000 of a cryptocurrency in March of this year, but by November it was only worth $8,600. You are sitting on an unrealized loss of $6,400. If you sell the cryptocurrency before December 31, you’re able to offset your taxes by the $6,400 loss, meaning you won’t pay taxes on $6,400 of your total gross income for that year.
Above, the cost basis for the cryptocurrency was $15,000, but before selling, you’ll want to ensure that you know your cost basis so that you accurately record the value lost. Determining your cost basis in investment is done either by First-in-First-Out (FIFO) or Last-in-First-Out (LIFO). FIFO is the preferred and most common method, meaning if you have multiple investments in the same cryptocurrency, your gain or loss is the difference between the sale price and the earliest buy price when you go to sell.
When Should You Harvest Your Cryptocurrency Losses?
Cryptocurrency tax-loss harvesting is only a viable strategy for those who will benefit from it on their tax return. To know whether or not you will benefit from crypto tax-loss harvesting on your tax return, you will need to assess your gross income and determine if lowering your taxable income is worth selling your cryptocurrency at a loss – remember you can always reinvest the money back into cryptocurrencies; it’s simply the act of selling with which you claim the loss on your tax return.
For those who are expecting a hefty tax bill or are in a higher tax bracket, realizing cryptocurrency losses can lower the amount you end up paying to the IRS. If you prepay your taxes through your employer, this can also increase your tax return, as you may have overpaid, especially on the amount paid under the highest tax bracket in which you qualify.
Another reason to harvest your cryptocurrency losses? If you are sitting on losses right now but anticipate large gains in the coming year. Even if you don’t really need to lower your tax bill for the current year, it might be a good idea to realize the losses for the immediate tax relief and then reinvest back into the cryptocurrency with, hopefully, a minor fluctuation in the actual price of the investment – hopefully, it continued to drop between selling and repurchasing.
The Wash Sale Rule
Under the IRS’ Wash Sale Rule, a person must wait 30 days after selling a security before they can reinvest the proceeds back into a security. This does not currently affect cryptocurrency sales, as the IRS classifies cryptocurrency as property, but if the IRS reclassifies cryptocurrency as securities, then the Wash Sale Rule will apply, and you will need to take the 30-day window into account when determining whether to harvest your cryptocurrency losses or not.
Consult Your Accountant or Tax Attorney
Before you decide on anything, you should discuss crypto tax-loss harvesting with your accountant or tax attorney to make sure it will benefit you and your specific financial position.
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