Get paid for crypto losses
The first seven months of the year have been disastrous for most cryptocurrency owners. Estimates from coinmarketcap.com describe the size of the losses. The global market value of crypto assets, including cryptocurrencies and stablecoins, approached $3 trillion in November last year. That’s trillion with a “t.” By global market cap, I mean the total value of significant crypto assets in existence.
When Super Bowl ads starring Hollywood A-Listers were run for crypto wallets, crypto had started to fall. Now, the same source estimates the total market cap for crypto to be close to $1 trillion, a two-thirds decline in just over six months. Prominent cryptocurrencies such as Bitcoin and Ethereum have seen similar falls.
There is nothing we can do to recover the losses from the past. Crypto assets may see a strong resurgence in the second half of the year, but the value is what another buyer will pay for the asset. There is a silver lining to the crypto cloud in the form of the US tax code. For now, it appears that crypto owners can take advantage of a loophole that gives them tax benefits.
Experienced investors will recognize the strategy of tax-loss harvesting commonly used with stocks, mutual funds, ETFs and other more traditional financial assets. This applies to investments that are in your taxable account. When the value of a given financial asset is lower than what you paid for it, you are usually able to sell that asset and take a capital loss. Investors value capital losses because they can be used to reduce capital gains from other assets in the current year or in future years. You can also reduce ordinary income up to $3,000 a year, which is even more useful as it reduces income that would normally be taxed at a higher rate.
One of the pitfalls of capital loss harvesting is the wash sale rule. You cannot take a capital loss on the same asset (or a substantially identical one) that you have purchased in any account in the past 30 days or will purchase in the next 30 days. If you sell a stock, you cannot take a loss on that stock if you bought it four weeks ago or buy it in four weeks. That’s why tax loss strategies can be complex if you want to stay invested.
Cryptocurrencies fall into a completely different category than financial assets. According to IRS Notice 2014-21, “virtual currency is treated as property. General tax principles that apply to real estate transactions apply to transactions using virtual currency.” Wash sale rules generally apply to shares and securities, not property.
If crypto assets are not subject to the wash sale rule, crypto investors have an important advantage. Let’s say you bought Bitcoin late last year in a non-retirement account for $65,000, and then recently you sold that single coin for $25,000. On the same day, you buy one coin for the same $25,000. It looks like you’ll be able to take a short-term capital loss of $40,000. The loss can be used to offset other capital gains and up to $3,000 in ordinary income as noted before. Unused losses can be carried forward to future years. It can reduce your taxes by $8,000 or more, depending on your individual situation.
Please note that this law can change at any time and that your tax preparer may not agree with this interpretation. Consider this column an introduction to the idea of collecting crypto losses. You should retain your own tax advisor to execute this strategy, especially if the numbers are significant. If you want to be on more established legal ground, you can sell Bitcoin and with the proceeds immediately buy Ethereum – another asset. This is highly unlikely to be judged as a wash sale. Finally, don’t forget that you can simply keep the money from your Bitcoin sale and safely take the tax benefit.
David Gardner is a Certified Financial Planner with Mercer Advisors practicing in Boulder County. The opinions expressed by the author are his own and are not intended to serve as specific financial, accounting or tax advice. They reflect the author’s judgment at the date of publication and are subject to change. Cryptocurrencies are a highly speculative investment that involves a high degree of risk. Investors must have the financial ability, sophistication/experience and willingness to bear the risk of such an investment, and a potential total loss of the principal invested.
