Expert tips for harvesting crypto treasures

Although the entire cryptocurrency market lost around $1.4 trillion in 2022, some investors could have used the decline to save big when filing taxes through a strategy known as tax-loss harvesting, which can be useful for those with assets that have fell in value. . It’s too late to take advantage of the 2022 tax year, but it doesn’t hurt to plan ahead for 2023.

To understand tax loss harvesting, you first need to know how the Internal Revenue Service handles crypto gains and losses.

The IRS treats virtual currency as property. When you sell it at a loss, meaning you weren’t able to recoup the amount you paid for it, the agency allows you to use those losses to offset profits from other investments, known as capital gains. If capital losses exceed annual capital gains, investors can use the remainder to offset up to $3,000 from their ordinary income at tax time.

Capital gains are usually taxed at a lower rate than ordinary income, which includes what you earn at your job or from a side gig.

Remember that capital gains can only be offset by losses of the same type. Long-term gains, meaning you have held your crypto for more than a year before selling, can only be offset by long-term losses and short-term gains, meaning you have sold your crypto before one year, are offset by short-term losses.

Tax loss harvesting is a strategy that uses these rules to your advantage – and crypto holders can use it in a way that other investors cannot.

Unlike stocks, the wash sale rule does not currently apply to crypto. This rule states that you are not allowed to claim a tax credit if you sell a security at a loss and replace it with the same or a “substantially identical” security 30 days before or after the sale, according to the IRS.

This means that in theory you can sell your crypto, claim the loss and buy it back without having to wait the usual 30 days.

However, be careful not to use this loophole to abuse the tax system, says Shehan Chandrasekera, a certified public accountant and head of tax strategy at crypto tax software company CoinTracker.io.

If you often sell crypto at a loss, and immediately buy the same digital coin, the IRS will not allow the tax benefit, Chandrasekera told CNBC Make It.

“I wouldn’t advise anyone to do that. I would say just wait a reasonable period of time,” he says. “Of course you don’t have to wait the 30 days, but again, wait a reasonable amount of time before buying back the same coin.”

Some traders do this once a quarter, once a month or every two weeks, says Chandrasekera.

If you want to move forward with harvesting your crypto losses, it’s important to understand how it could affect your tax bill.

If you sell crypto that has appreciated in value and you have held for more than a year, the profit will be subject to capital gains tax. Although capital gains are taxed at lower rates than ordinary income, it’s even better to offset these gains against capital losses because it can reduce or eliminate the amount of tax you owe.

Say you bought crypto for $10,000 and later sold it for $13,000. You will face $3,000 in taxable capital gains. But if you incurred $3,000 worth of losses on crypto transactions, you would be able to offset the tax you owe, says Chandrasekera.

And if you have $10,000 in capital losses in one year but only $3,000 in capital gains, you can carry over the remaining $7,000 and use it to offset gains realized in the future, says Chandrasekera.

“You can carry it forward into future years indefinitely,” he says. “In the second year, if you don’t have a couple of wins to break even, that’s fine. You can carry it on until you die.”

It is important to note that harvesting crypto tax losses requires careful tracking of how much you have paid and sold crypto for. This can be difficult for some investors without the use of reputable software that can track your transactions for tax reporting purposes.

And remember that every investor’s tax situation is unique. Talk to your tax advisor before making any changes to your portfolio.

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