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CRYPTO TAX-LOSS HARVESTING: THE EXPERT GUIDE FOR US INVESTORS

Written by Freddy King, Reviewed by David Canedo, CPA

May 11, 2023 • 10 min read

With the tax deadline looming, tax loss harvesting can be a valuable strategy
for US investors looking to minimize their tax liability when investing in
cryptocurrencies and other digital assets.

Last Updated: May 11, 2023

     In this article:

 1.  What is Crypto Tax-Loss Harvesting?
 2.  How Harvesting Your Crypto Losses Works
 3.  Example
 4.  What are the Benefits of Harvesting your Tax Losses?
 5.  Offset Your Crypto Gains
 6.  Offset Capital Gains Elsewhere
 7.  FOMO When it Comes to Selling? – Additional Strategies
 8.  Buy Everything Back Shortly After – Wash Sale Rule Risk!
 9.  Low-risk Rebalancing Strategies
 10. Rebalance Your Portfolio
 11. Plan For Liquidity Needs
 12. Find Correlated Cryptos
 13. Find a Proxy For The Asset
 14. What Are The Risks of TLH?
 15. The Wash Sale Rule and Crypto Explained
 16. What About Short vs. Long-Term Gains?
 17. How to Start Tax Loss Harvesting?
 18. How Accointing’s Tax Loss Harvesting Tool Can Help
 19. How to Use Accointing’s TLH Tool?
 20. Does Tax Loss Harvesting Work on My NFTs?
 21. FAQs
 22. Which Disposal Method Is Best for Crypto Tax Loss Harvesting?
 23. What If I Have both Unrealized Losses and Gains for a Single Crypto?
 24. Is There a Limit To How Much I Can Tax-Loss Harvest?
 25. Is Tax-Loss Harvesting Considered Tax Evasion?


WHAT IS CRYPTO TAX-LOSS HARVESTING?

Tax loss harvesting involves selling investments that have decreased in value to
offset the gains from investments whose value has increased. By doing this, you
can reduce the taxes you owe on your overall investment portfolio.

Crypto investors also use tax-loss harvesting to reduce their taxable gains by
selling crypto investments at a loss. These realized losses are then used to
offset capital gains from profitable trades, lowering the total amount subject
to capital gains tax.

While many HODLers may want to avoid selling positions, a good investment
strategy always includes minimizing and deferring taxes by turning those
investment losses into actual tax savings.

In addition, the strategy can also be used as a way to diversify an investor’s
portfolio or hedge against market volatility. When done correctly, it can help
investors maximize their profits and minimize their risk in the crypto market.


HOW HARVESTING YOUR CRYPTO LOSSES WORKS

When you purchase any asset, you have an acquisition cost (cost basis) which is
equal to the amount you paid for this asset (plus any brokerage costs or fees).
As the market fluctuates, the value of your asset goes up or down, creating an
unrealized (paper) gain or loss depending on the market’s direction.

For tax purposes, claiming a loss on an asset is only possible once you sell it
or exchange it. If you hold an asset with unrealized capital losses during a
market downturn, selling or exchanging it allows you to claim the loss. You may
later buy back the same asset at the reduced price for HODLing.

The selling or swapping of the asset constitutes a taxable disposal, which means
that you recognize your gain or loss for tax purposes. Since you had an
unrealized loss, by selling, you can now claim the loss.


EXAMPLE

Elon buys 1 BTC at $55,000. The price of BTC is now at $20,000, meaning his 1
BTC has a $35,000 unrealized loss ($20,000 current price – $55,000 acquisition
cost).

If Elon harvests his losses and sells his BTC at $20,000, he can claim this
$35,000 loss and use it to offset any gains made elsewhere. This is a simplified
example of how tax loss harvesting works. For more detailed examples of
offsetting gains, income, and carrying losses, refer to the section below.


WHAT ARE THE BENEFITS OF HARVESTING YOUR TAX LOSSES?


OFFSET YOUR CRYPTO GAINS

So you sold your crypto at a loss, how does this help you? This helps because
you can use these losses to your advantage.

Offset your short-term and long-term capital gains. Short-term capital losses
are first netted against short-term capital gains. Long-term capital losses are
netted against long-term gains. Net short-term gain or loss and net long-term
gain or loss are added together. This means that your short-term losses can
offset your long-term gains and vice versa.

If you have an overall capital loss, you can use up to $3,000 per year of these
losses to offset ordinary income! This includes salaries and wages & active
business taxable income. Any losses in excess of $3,000 in a year can be carried
forward to future tax years indefinitely until used.

OFFSETTING CRYPTO CAPITAL GAINS AND INCOME EXAMPLE

Elon purchased 1 BTC at $3,000 in 2019 and sold it at $35,000 in 2022. His gain
therefore is $32,000.

Elon also bought 1 BTC in November 2021 at $55,000. The price of BTC is now at
$20,000. If Elon sells his BTC at $20,000, he can claim this $35,000 loss in his
taxes.

His short-term losses are $35,000

His long-term gains are $32,000

Elon can combine his gains and losses to get to a net capital loss of $3,000,
which he can use to offset his wages from his job. If Elon had not sold his BTC
purchased in November 2021, he would have had to pay taxes on a $32,000 gain.
Instead, he pays no tax after realizing his losses.

LOSS CARRY OVER EXAMPLE

Elon purchased 1 BTC at $3,000 in 2019 and sold it at $25,000 in 2022. His gain
from the above is $22,000.

Elon also bought 1 BTC in November 2021 at $55,000. The price of BTC is now at
$20,000,if Elon sells his BTC at $20,000, he can claim this $35,000 loss in his
taxes.

His short-term losses are $35,000

His long-term gains are $22,000

Elon can combine his gains and losses to get to a net capital loss of $13,000,
of which he can use $3,000 in the current year against other taxable income,
and carry forward $10,000 to use against future capital gains

If Elon had not sold his BTC purchased in November 2021, he would have had to
pay taxes on a $22,000 gain – instead he pays no tax, has a loss and has losses
to carry forward and use against future gains.


OFFSET CAPITAL GAINS ELSEWHERE

What if you have a taxable brokerage account with other gains? You may have a
mutual fund which will pay you capital gain distributions. These are taxable
distributions as capital gains that you can offset by harvesting losses in other
assets, such as crypto.

You can offset capital gains (and capital gain distributions from mutual funds)
from any taxable account with other capital losses from crypto assets. So if one
class of investment is outperforming the other, sell your losers, claim your
losses and make your tax life more manageable.


FOMO WHEN IT COMES TO SELLING? – ADDITIONAL STRATEGIES

FOMO is a bad reason not to make a smart financial decision. Let’s go back to
our examples with Elon. In example 2, if he had not sold his BTC, he would have
paid tax on a $32,000 gain.

Depending on his tax bracket, this could be up to a 30% capital gains tax rate
even if it’s a long-term gain (when you consider the 3.8% net investment income
tax plus state taxes). What is worth more to you? 20% to 30% on $32,000 ($6,400
to $9,600) or making a trade, paying a few fees, and no longer paying the
capital gains tax?

To solve the FOMO, here are two strategies you can use. You can

1) repurchase everything shortly after or

2) plan a smart low-risk rebalancing strategy. Let’s unpack both.


BUY EVERYTHING BACK SHORTLY AFTER – WASH SALE RULE RISK!

You may ask, can I sell everything and repurchase immediately? Yes and
no….proceed at your own risk. In traditional finance, the Wash Sale Rule forbids
traders from doing just that. It states that if you repurchase assets after
selling at a loss, you cannot claim this loss, and you defer the loss until you
sell this repurchased asset. However, as of today, this does not apply to
crypto.


LOW-RISK REBALANCING STRATEGIES

Harvesting losses brings opportunity, and it’s wise to think twice about piling
straight back into the same asset, especially if it was sold for profit. Once
you have realized losses, you can take stock, assess your options and plan an
intelligent low-risk investment strategy.


REBALANCE YOUR PORTFOLIO

As asset prices fluctuate and markets change over time, you may not need to buy
back the crypto you sold. Instead, take advantage of an opportunity to think of
a better asset allocation.

Reinvesting a portion of those gains into other assets to diversify your risk is
a good idea. While this isn’t tax loss harvesting, it’s part of a good
investment strategy that can help your portfolio absorb some of the volatility.


PLAN FOR LIQUIDITY NEEDS

It’s essential to have cash available to pay taxes and also to take advantage of
great dip-buying opportunities. So once you have sold any crypto at a loss,
allocate part of this cash to sit on the sidelines.

Having no cash available to pay taxes or take advantage of great dip-buying
opportunities is never good. Once you sell your losing cryptos, you can allocate
part of this cash to sit on the sidelines. Sure, this money won’t grow 10x, but
if you sold your losing assets in December 2021 when the markets started to dip
and sat on cash, you would be in an excellent position as of June 2022 to buy
back at much better prices.


FIND CORRELATED CRYPTOS

Take advantage of crypto assets that correlate with their price movements. Sure,
the crypto markets are first linked to the Nasdaq, and then to BTC, but beyond
that, you can find similar coins with a more significant correlation in their
price movements.


FIND A PROXY FOR THE ASSET

Suppose you’re an investor who likes to have exposure to a particular area of
crypto, such as gaming tokens or layer-2 blockchains. In that case, you can keep
your exposure without leaving the market entirely by selling your crypto at a
loss into a similar token in the same field. Whilst this keeps exposure, you
must do your own research as the tokenomics between projects often differs.

Another option is to find companies heavily associated with the asset, such as
Microstrategy (MSTR), Grayscale Bitcoin Trust (GBTC) or a mining company. Many
other assets move with BTC, and buying into those would not impact your ability
to deduct your loss.

If you sold your ETH, you could look into the Grayscale Ethereum Trust (ETHE).
You get the point – find other ways to keep the same exposure. Once the SEC
approves a Bitcoin ETF, that will also be an excellent way for many investors to
get direct exposure to BTC.

Remember that it’s key to have a good investment strategy. This includes
considering the tax implications and having a tax strategy. Don’t just invest
without goals, as emotions will get in the way when it comes time to take
action.


WHAT ARE THE RISKS OF TLH?

While tax loss harvesting can be beneficial, there are certain associated risks
that you should consider before implementing this strategy. Some things to be
vigilant of are market fluctuations and changes in personal income or tax rates
that can further affect the taxes owed on an asset in the future.

Additionally, there is the risk of incurring higher taxes in the future due to a
lower cost basis. When the cost basis is lowered through tax-loss harvesting,
capital gains will be higher due to the larger difference between the sale price
and cost basis.

Finally, there is a risk of triggering the wash sale rule if the same or
substantially similar security is purchased within 30 days of selling the
security for a loss. Let’s review the wash sale rule.


THE WASH SALE RULE AND CRYPTO EXPLAINED

If we take a look at the Internal Revenue Code §1091 (which provides the law on
wash sales), we see that this law applies specifically to “stocks or securities”
and the IRS FAQs clearly state that cryptocurrencies are property.

This has created a tax loophole for crypto traders for the time being. However,
this will most likely be closed in the near future. Legislation packages have
already had a provision to close this loophole, and while this has yet to pass,
it is just a matter of time as the IRS and Congress seek to stop this tax game.

While as of today this rule technically does not apply to crypto, if you want to
be extra safe, you should rethink buying back the same assets within 30 days (or
the 30 days prior to selling at a loss).


WHAT ABOUT SHORT VS. LONG-TERM GAINS?

Short-term gains refer to profits made when an asset is held for a year or less,
while long-term gains refer to profits made when an asset is held for more than
one year. The IRS requires that short-term losses are offset against short-term
gains first and long-term losses against long-term gains first.

If any capital losses remain after this process has been completed, they can be
used to offset capital gains of the other type. This means that investors should
consider their holding periods before tax loss harvesting to make the most of
these potential savings opportunities.


HOW TO START TAX LOSS HARVESTING?

The only tool you need to get started is a reliable portfolio tracker, so a
great first step is to set up a free account with Accointing and connect your
wallets. From here, Accointing will show you your unrealized gains and losses on
each of your investments, helping you identify potential tax loss harvesting
opportunities.

However, before you dive right into realizing losses, it’s crucial to understand
the basic principles and how to use software that allows you to take advantage
of these opportunities and generate more tax-efficient income. That’s where
Accounting’s tax loss harvesting tool comes in.


HOW ACCOINTING’S TAX LOSS HARVESTING TOOL CAN HELP

Accointing’s tax-loss harvesting tool helps you harvest your losses as
effectively and efficiently as possible. On the tools tax loss harvesting
dashboard, you’ll see your investments grouped by the asset. They are further
divided into each wallet holding that asset and then into ‘tax lots’ as shown in
the example below.

These tax lots are determined by what disposal method you use (FIFO, HIFO etc.)
and show the order in which they would be sold or disposed of. The tool displays
each tax lot’s unrealized profit or loss, and if the unrealized gains are short
or long-term. You will also be shown how long a tax lot has left before it
becomes a long-term gain, making this a handy tool for planning future trades.

On top of this, one of the most important advantages this tool provides is the
information provided in the far right column. This column displays the tax
impact if you were to start realizing the gains or losses from this specific
wallet on this particular asset. How does this help? You can determine the most
tax-efficient coin to harvest losses on throughout your crypto portfolio.

Alternatively, if you want to harvest losses on a specific asset, let’s use
Bitcoin for example; by using this tool, not only can you identify which wallet
is the most tax efficient to sell from, but you can also see how much Bitcoin
you need to sell before you start selling into profit.


HOW TO USE ACCOINTING’S TLH TOOL?

Check out the video embedded below for a rundown of how the tax loss harvesting
tool works.


DOES TAX LOSS HARVESTING WORK ON MY NFTS?

Yes, if you have NFTs that have decreased in value since you acquired them, you
can sell them to realize a taxable loss. Likewise, you can also use a burn
address and realize a loss in exchange for $0 proceeds. For more information on
the taxation of NFTs head to our US Guide for NFT Taxes.


FAQS


WHICH DISPOSAL METHOD IS BEST FOR CRYPTO TAX LOSS HARVESTING?

While investors need to understand the differences between each method (HIFO,
FIFO, LIFO etc.), there is no concrete answer regarding which method is best for
tax loss harvesting. This is because everyone’s tax position is different and
specific methods may be better suited to your individual circumstance.

If you are still determining which disposal method is suitable for you, it is
recommended that you consult with a qualified tax advisor before selecting one.


WHAT IF I HAVE BOTH UNREALIZED LOSSES AND GAINS FOR A SINGLE CRYPTO?

In this case, it’s crucial to document your tax lots accurately to ensure that
you are reporting losses rather than gains. Accointing’s tax loss harvesting
tool will show you how to harvest your losses on a single currency as
effectively as possible.


IS THERE A LIMIT TO HOW MUCH I CAN TAX-LOSS HARVEST?

No, but there are limits on how many losses you can deduct from your taxes. For
example, when filing your taxes, you can only deduct up to $3,000 of losses to
offset any capital gains. Any amount higher than this threshold for the year
cannot be deducted but may be carried forward to offset capital gains or income
in future tax years.


IS TAX-LOSS HARVESTING CONSIDERED TAX EVASION?

No, tax loss harvesting is a perfectly legal way to reduce tax liability.
However, the IRS looks closely at such crypto transactions to ensure they’re
genuine losses and not simply a way to hide taxable income. To ensure compliance
with IRS regulations, it is always best to consult a qualified professional
before engaging in tax planning strategies.

Given the volatile nature of cryptocurrency, it’s critical to understand how tax
loss harvesting works and how you can use it to benefit your portfolio from a
tax standpoint.

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