The crypto market is bearish at the moment and there’s no easy way to say this, but crypto markets are having a tough year. For the tax-savvy investors, however, there’s a bright side to this bearish cloud.
The term “bear market” is used when the market has lost more than 20 percent in a given year. This year, Bitcoin is down by 35 percent, Ethereum is down by 43 percent, and several other coins are down by even more. If you have lost money on a crypto position, you can use this to take advantage of these unrealized losses on your crypto tax forms. Let’s see how.
Tax Loss Harvesting and the Wash-sale Rule
Let’s assume you invested $25,000 in Ether and $25,000 in Bitcoin through a crypto exchange. When you bought both the coins, their prices were $55,000 and $3,500 respectively. As a result, you ended up owning 7.14 ETH and 0.45 BTC.
After a few months, the market started to go down, but you retained the coins throughout the bear phase. You still own the same amount of coins but their values are down significantly. The present value of Bitcoin is approximately $29,000 and ETH’s value is approx. $1,900. So, is $26,616 unrealized loss of $23,384?
To realize this loss, you can dispose of the coins. The loss of $23,384 can be used to offset other gains in your investment portfolio where you booked a profit. This activity is called tax-loss harvesting.
In the conventional financial market, you have to wait for 30 days after selling an asset to rebuy the same asset. Let’s say you purchase the same asset within 30 days, the loss cannot offset a gain. This is known as a “wash sale.” For instance, if you bought Tesla stock at $1,500 and sold it for $800, you’d have to wait for 30 days to repurchase Tesla stock to claim the loss of $700.
But this rule hasn’t been put into the tax code of crypto, yet. If you wish to hold Bitcoin and Ether, you would sell the coins and buy them immediately to offset gains in the crypto tax form. This doesn’t create a wash sale like traditional financial securities.
The absence of the wash-sale rule in crypto is a blessing for crypto investors as crypto can be highly volatile and the prices can move significantly in the 30-day period. The ability to preserve a position and realize a loss at the same time boosts long-term returns and improves tax efficiency.
What More Can Tax-loss Harvesting Do?
One amazing benefit of losses realized from crypto gains is that they can be used to offset tax liability on your crypto tax forms on any gains realized. It doesn’t have to be only on crypto gains.
It is important to note that crypto taxation is a new subject for many tax accountants. As an investor, you have to track your transactions and if your crypto exchange does not provide 1099 forms, using crypto tax software to fill up your crypto tax forms is essential.
The Takeaway
While the investors wish that the value of crypto needs goes down, unfortunately, this is simply not possible due to the highly volatile nature of cryptocurrency. Moreover, you should understand tax rules that might provide a unique opportunity to help ease the tax burden in a bearish market. The rules might change in the future, but for now, it is proving to be an essential tool in financial planning.
FAQs
1. What is tax-efficient loss harvesting?
Tax-loss harvesting lets investors sell investments that are down and replace them with reasonably similar investments to offset capital gains. In the traditional financial market, you have to wait for 30 days from the date of selling an asset to repurchase the same asset. This is known as a “wash sale.” But this rule hasn’t been put into the tax code of crypto, yet.
2. Is tax-loss harvesting worth it?
Tax-loss harvesting offers one of the biggest advantages when you wish to reduce your regular income. The absence of the wash-sale rule in crypto is a blessing for crypto investors as crypto can be highly volatile and the prices can move significantly in the 30-day period. The ability to preserve a position and realize a loss at the same time boost long-term returns and improves tax efficiency.
3. How long can you tax loss harvest?
A taxpayer can write off up to $3,000. The same amount is also applicable to long-term capital losses. However, long-term losses can be carried forward to future years. For instance, a $12,000 loss can be paid over four years.
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Is tax-loss harvesting illegal?
No, tax-loss harvesting is not illegal. It is perfectly legal if done in the right manner. It lets investors offset their capital gains taxes by selling an investment for a loss.