Anything worth doing in life comes with risks. That is no exception when it comes to tax loss harvesting or getting some losses on paper when it comes to your crypto stock. In an effort to reduce excessive inflation, the Federal Reserve has recently implemented tougher rules and significantly raised interest rates. The crypto market has been negatively impacted by rising interest rates as well as the deteriorating economic climate, as is the case with almost all financial markets.
The market cap of all cryptocurrencies recently fell below $1 trillion, the first time this has happened since January 2021. The prices of digital currencies like Bitcoin and Ethereum are at their lowest points since 2020. Now that the market is in a bear phase, it's time to employ a technique like crypto tax-loss harvesting. How do you go about doing that?
Let’s dive in!
Crypto tax-loss harvesting involves selling assets at a loss so that the capital gains from other investments cancel out the loss. When people use this tax strategy, they can lower the amount of tax they have to pay.
When you do crypto tax-loss harvesting, you can lower the amount of taxes you owe by selling assets for less than what you paid for them. This can be helpful if you made any capital gains during the year. Realized gains can be taxed, so keep that in mind. When you sell an asset at a loss, you get capital losses, which you can use to cancel out your capital gains.
This tax strategy is often used by crypto investors at the end of a tax year or when the market as a whole has dropped a lot. Crypto tax-loss harvesting can help you pay less tax if you use the right tool or piece of software.
Yes, it is! It's 100% legal and is not considered tax evasion. But if you want to use crypto tax-loss harvesting the right way to cut your income taxes for the year, you'll need to follow certain wash sale rules. Note: Rules like these can be different from one country to the next.
To get the most out of the crypto tax-loss harvesting strategy, you need to follow a crypto wash sale rule, which can be different from one country to the next. This rule says that a taxpayer can't deduct losses from a security or stock sale if they buy the same asset back within 30 days.
This rule was put in place specifically to stop taxpayers from selling assets just to get tax breaks. Let's say you made a lot of money on your investments this year. If so, you may find when you look at your holdings that you also have a lot of unrealized losses.
In this case, you could sell these cryptocurrencies to get a realized loss. Then, you could buy all of these currencies back at a lower price before the value of the crypto goes up. By using a wash sale, the capital losses you've gotten aren't really losses because you put the money from the sale back into the same asset. Even though these losses wouldn't be real, you could still use them to lower your tax bill. Many tax offices have wash sale rules because they know how easy it is to take advantage of crypto tax-loss harvesting. With these rules, an investor can't use a wash sale to make money.
When you look at the tax laws in the U.S., U.K., Canada, and Australia, you will find that each country has different limits on capital losses.
In the U.S., there is no limit on how much a capital loss can be used to cancel out a capital gain. On the other hand, you have to follow some special rules if your total capital losses are more than your total capital gains. In this case, you can only use $3,000 in capital losses to cancel out $3,000 in capital gains. Any losses left over can be carried over to the next tax year.
Canada's rules on capital losses are a little different in that you can only use half of your total capital losses as a tax deduction. But there is no limit to how much can be taken off of capital gains. If you lose more money than you make in a given year, you can keep these losses for as long as you want.
In the United Kingdom, every person has a capital gains tax allowance of £12,300. If the amount of your capital gains is more than the amount of your tax allowance, you can use your capital losses to lower your capital gains until they are less than the amount of your tax allowance. You can use as many capital losses as you want for crypto tax-loss harvesting right now.
If you live in Australia, you can use your capital losses to make up for your capital gains. This choice is not limited in any way. But you must use up all of your capital losses before you can carry them forward to future tax years. This means that you cannot carry forward capital losses if you still have capital gains.
Cryptocurrencies are classified as capital assets, which means they work similarly to stocks or real estate. You won't be able to make or lose money with cryptocurrency unless you trade, sell, or spend it. Assume you own a cryptocurrency that has lost half its value since you purchased it. This is not considered a loss in cryptocurrency until you exchange or sell your coins.
Crypto tax-loss harvesting is an effective approach for lowering the amount of taxes owed on your annual tax return by offsetting capital gains. Don't forget that even if you didn't generate any capital gains this year, you can still harvest. Finding additional losses can also help you reduce your taxable income or even cancel out profits from stocks or other types of assets.
As an example: Wash sale rules already apply to stocks, bonds, ETFs, and other investments so you can't just take losses on paper and then purchase the position again soon away.
You can, however, do so right now in Crypto. You can sell a depreciated Bitcoin, accept the loss on paper while the market is down, trade it in principle, and then trade it back to Bitcoin, and you will have lost nothing but transaction costs. With those transaction costs, you lose thousands of dollars in paper. However, Congress may say no to washed-out rules and make that retroactive. So note that, it is a risk!
The key advantage of the crypto tax loss harvesting approach is that it allows you to reduce your capital gains taxes. And also, depending on your country, you may be eligible for additional benefits. For example, you may be able to deduct some of your capital losses from your income, putting you in a lower tax category. The taxes you owe would be significantly reduced if you moved to a lower tax rate. But keep in mind that crypto tax-loss harvesting does not guarantee that you will be able to avoid paying capital gains taxes eternally.
The goal of this technique is to postpone these taxes. By delaying your capital gains taxes, you will have more money each year to invest in cryptocurrency. Crypto tax-loss harvesting is an effective approach for lowering the amount of taxes owed on your annual tax return by offsetting capital gains. Don't forget that even if you didn't generate any capital gains this year, you can still harvest. Finding additional losses can also help you reduce your taxable income or even cancel out profits from stocks or other types of assets.
This tax strategy can be very helpful, but there are also a few possible downsides. As long as you follow the rules about wash sales, tax officials won't come to check on you. However, if you buy and sell cryptocurrency a lot, your transaction fees will add up. Depending on the exchange you use, each transaction can cost as much as 4% in fees. If you want to make sure you're actually saving money, you need to figure in these fees when figuring out how much crypto tax-loss harvesting will lower your tax bill.
As we've already said, harvesting your crypto tax losses doesn't get rid of your capital gains. You will still have to pay taxes on these gains at some point in the future. When you sell back-bought crypto assets, you'll have to pay taxes on your capital gains.
If you buy crypto when the price is much lower because of the recent drop, your capital gains may be much bigger than you thought. Depending on how big these gains are, they may wipe out the tax savings you got from this strategy in the first place.
Although crypto tax-loss harvesting shouldn't be used continually, a fall in market circumstances is the ideal opportunity to employ this tax method. Utilizing your unrealized losses in this way can help you avoid paying immediate taxes on your capital gains. This tactic can assist you in keeping your assets intact while the market is weak. There aren't many issues with putting this method into practice because crypto sales made in the United States are exempt from the wash sale regulations. When you do decide to adopt this strategy, be sure to make use of some of the resources previously stated to prevent costly errors.
We hope this information was helpful! If you have any questions, feel free to reach out. We’d be happy to chat with you.
Crypto tax-loss harvesting is a great way to save money on taxes because it lets you put off paying taxes on capital gains until a later date. Now that the market is in a bear market, it's time to use strategies like crypto tax-loss harvesting.