Key Takeaways
- You can use realized losses to offset realized gains and thus reduce your tax burden.
- There’s no limit on how much capital gains tax you can offset by tax loss harvesting.
- Various platforms let you import your crypto transaction data to identify tax loss harvesting opportunities automatically.
Tax loss harvesting involves selling some assets at a loss to offset capital gains from other assets. You can use this strategy to reduce taxes on the gains from your crypto investments.
What Is Tax Loss Harvesting In Crypto?
Tax-loss harvesting implies purposely selling some assets at a loss to offset the amount of capital gains tax you owe on other assets sold for a gain. It's a strategy often employed by savvy investors to reduce taxes on short-term capital gains as well as long-term capital gains.
When you trade crypto or NFTs any realized profits constitute income subject to capital gains taxes. You can reduce the burden of crypto taxesby selling some crypto assets at a loss to offset gains from other crypto asset sales.
Pros And Cons Of Tax Loss Harvesting Crypto
How To Tax Loss Harvest Cryptocurrency
It’s not only capital gains income that tax loss harvesting helps you minimize. You can also use it to reduce the tax burden on your ordinary income. There’s a limit on how much you can offset against ordinary income in a given tax year – $3,000 for American taxpayers – but no limit for capital gains income. Considering this limit, you can understand why tax loss harvesting is mainly used to offset capital gains instead of ordinary income.
Step 1:The first step is deciding what inventory method (HIFO, LIFO, FIFO, etc.) you'll use to calculate the cost basis of your crypto investments for filing your crypto taxes.
Step 2:After deciding on the inventory method, you'll need to track all your crypto transactions to identify any realized losses and gains you've made throughout the year. You can do this manually or using crypto accounting software such as TokenTax. The latter is the more convenient method.
Step 3:With your unrealized capital losses in view, decide which assets to sell to harvest realized losses you can use against capital gains. Complete your trades, then export or manually input the data into your preferred tax filing software and submit it to the appropriate tax authorities during tax season.
Crypto Tax Loss Harvesting Software
Various platforms can scan your crypto transaction data and automatically identify tax loss harvesting opportunities. This process is more convenient than manually combing through transactions and calculating the unrealized losses. These platforms include:
1. CoinTracker
You can import your transaction data directly into CoinTracker using an API key (from a supported exchange/wallet) or a CSV file. The app then identifies and lists tax loss harvesting opportunities for you in a tabular format, and the final choice on which assets to sell is yours. You can generate tax forms with the app and export them to your preferred tax filing platforms.
2. CoinLedger
Similarly, CoinLedger lets you import transactions via APIs or by uploading a CSV file, and it identifies potential tax loss harvesting opportunities for you.
3. TokenTax
TokenTax also lets you import transactions in a similar vein and identifies tax loss harvesting opportunities. The main drawback with this platform is that it’s integrated with only one tax filing platform, TurboTax, while the others have multiple integrations.
Tax Loss Harvesting Crypto Calculator
The formula for tax loss harvesting is simple. It requires subtracting your realized capital losses from realized capital gains in a given tax year and paying capital gains taxes on the difference.
Tax Loss Harvesting Example
Here’s a standard example of tax loss harvesting:
- Jessica purchases one BTC for$19,000, holds it forthree months and sells it for$21,000. In this case, she made a short-term capital gain of$2,000.
- In that same year, Jessica buys1 ETH for$1,330, holds it forfour months, and sells it for$1,000. In this case, she has made a short-term capital loss of$330.
- Jessica can offset the$2,000 gain on the BTC trade with her$330 loss on the ETH trade. Thus, instead of paying capital gains taxes on$2,000, she’ll pay it on$1,670 ($2,000-$330).
Does The 30-Day Wash Sale Rule Apply to Cryptocurrency?
In the US, the wash sale rule applies to securities, and the IRS currently defines crypto assets as property, not securities. Technically, it means the rule doesn’t apply to cryptocurrencies. The Biden administration tried to pass a bill imposing the wash sale rule on digital assets and commodities, but wasn’t successful. Yet, it implies that the government has its eyes set on closing what it deems a tax loophole.
Even if the US government closes this loophole, you can get around it by selling one crypto asset and buying a similar one, e.g., swapping Ether (ETH) for Solana (SOL). As always, it’s prudent to consult a certified tax professional for advice concerning this rule when preparing your taxes.
In other countries, such as Australia and Canada, the wash sale rule applies to cryptocurrencies, so proceed with caution.
Crypto Tax Loss Harvesting in Different Countries
Different countries have different rules governing tax loss harvesting for cryptocurrencies. The table below shows the rules for four major tax jurisdictions:
| US | Doesn't apply, currently | None | First in, First out (FIFO), Last in, First out (LIFO), Dollar-cost averaging | End of the calendar year (December 31st) |
|---|---|---|---|---|
| UK | Applies (30-day window) | None | Cost of purchase or average cost basis | January 31st, following the end of the tax year |
| Canada | Superficial loss rule | None | Adjusted cost basis – the cost of the asset plus associated expenses, e.g., transaction fees | The last business day of the year |
| Australia | Applies | None | Cost of purchase | October 31st each year |
When To Tax Loss Harvest Crypto
You should tax harvest near the year's ending when it's easy to estimate your realized gains, or during market slumps when the potential realized losses are highest. For instance, the general plunge in the stock market and the crypto market crash this year provides more opportunities to sell investments at a loss to offset gains elsewhere. If you wait until next year, the market could rise and eliminate those opportunities.
How Much Of Your Losses Should You Harvest?
There is no limit to tax-loss harvesting, and losses can be used in future years even if you don’t have capital gains to offset this year. Thus, prudent investors should consider harvesting all the losses they possibly can.
If you don’t want to change the makeup of your portfolio, you can rebuy the sold crypto assets immediately (at least, until the IRS closes the crypto wash sale loophole), or you can buy an asset that you feel will perform similarly (sell ETH to buy another token like SOL, as an example).
Risks Of Tax Loss Harvesting Crypto
- Wash Sale Rule:Some tax jurisdictions have the wash sale rule that prohibits selling an investment at a loss and repurchasing the same investment within a specified period. If you violate this rule, you can't offset any loss from the initial investment.
- Portfolio Tracking Error: Tracking error is the difference in performance between your portfolio and its corresponding benchmark, e.g., the S&P 500. Selling some assets for tax loss harvesting can increase the negative tracking error of your portfolio.
- Missing Out On Potential Future Gains: Markets are dynamic, so a losing investment today can end up being profitable within a short time frame. If you sell an asset for tax loss harvesting purposes, you may miss out on possible future gains on that asset if you don't repurchase it immediately.
To Sum It Up
Tax loss harvesting is a legal strategy that anyone can use to minimize their tax burden, but many people don’t know how to go about it. In this article, we explained what tax loss harvesting is, the rules governing it, and which platforms can help you identify tax loss harvesting opportunities with ease.
Frequently Asked Questions
Losses on any asset aren’t taxed, but you must report them on your tax forms. You can often use the losses to offset gains in future years, so it's worth tracking and reporting them accordingly.
Yes, tax loss harvesting can significantly reduce your tax burden. Prudent traders regularly tax loss harvest to reduce their tax burden over time.
Doing so constitutes a “wash sale,” which is prohibited in some jurisdictions but allowed in others. Study the tax laws of your country and consult with a certified tax advisor if you want to do so. In the USA, this tax loophole is currently still open.
You can harvest the losses on one or more trades of a single asset against the gains on trades of the same asset.
NFTs are assets, so you can harvest losses on your NFT trades just as with any cryptocurrency. Sell them like any other asset to create a realized loss.
Pros
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