crypto strategy

Use Your Crypto Losses to Turn the Tide Against the IRS

Disclaimer: This is not tax advice, and we strongly recommend that you consult a tax professional before proceeding with any transaction.

This year has not been kind to a crypto investor’s wallet. Luckily, there’s a silver lining for all bag holders with significant losses: tax loss harvesting. Tax loss harvesting is a tax minimization strategy where you strategically sell at a loss to offset gains from other investments (i.e., use crypto losses to offset equity gains).

Savvy investors will use this strategy wisely throughout the year to avoid accumulating excessive taxable gains in any given year, which is especially important for anyone living in high-tax states like California or New York.

Jaimin Desai is the co-founder and CEO of Reconcile. This coin is part of CoinDesk tax week.

Here are a few things you’ll want to keep in mind about tax-loss harvesting.

When you reap tax losses, you keep the same portfolio value but slightly increase your after-tax return. Here’s how it works:

(Jaimin Desai)

As the example shows, harvesting tax losses helps investors maintain the same portfolio value, but reduces their tax liability by offsetting the gains with the losses. Keep in mind that tax loss harvesting is not always necessary and is more recommended for investors with significant tax liabilities or those taxed at higher rates.

There are no fictitious sales to keep in mind when harvesting tax losses with crypto. Under the wash sale rules, the US Internal Revenue Service will deny any loss if the same security is purchased within 30 days before or after the sale. Luckily for crypto investors, crypto is still technically considered property from a tax perspective, so it’s exempt from the restrictions of the wash sale rule.

That being said, there is yet another IRS rule called doctrine of economic substance, which essentially prohibits transactions made solely for the purpose of federal tax evasion. According to the IRS:

Under section 7701(o)(1), a transaction has economic substance if: (1) the transaction significantly changes (other than federal income tax effects) the taxpayer’s economic position ; and (2) the taxpayer has a substantial purpose (other than federal income tax effects) for entering into such a transaction.

So, to avoid breaking this doctrine, you could presumably sell and buy back the same crypto after a few days – the logic being that since crypto is so volatile, there is enough economic substance to justify selling and then buying back. However, selling and then buying back immediately could certainly raise some flags.

It’s also worth noting that if you have more losses than gains this year, you can deduct up to $3,000 (or $1,500 if you’re married and filing separately) of investment losses from your ordinary income. when filing income tax. Losses realized beyond these limits can also be used to offset gains in future years.

The IRS allows you to reduce your ordinary income (i.e. your salary) by deducting your investment losses. So if you earned $100,000 in 2022, you can reduce your taxable income by up to $3,000, for a new total of $97,000. Depending on your marginal tax rate and the state you live in, you could potentially save at least $1,000 in taxes just by realizing your investment losses.

Investments that are reported on Schedule D of your tax return include stocks, bonds, crypto, collectibles, and homes. So you can use losses from any of these asset classes to offset yourself and get up to $3,000 in deductible losses. For example, if you had $15,000 in crypto losses and $10,000 in stock gains, you would have a net loss of $5,000. You can deduct up to $3,000 and then use the remaining $2,000 of losses to offset gains in 2023 and beyond.

To sum up, harvesting tax losses using crypto is one of the best and most accessible investment strategies anyone can adopt. If you earn a lot of money or live in a high-tax state, you should consider tax-loss reaping because you may be able to save up to 50% on your earnings tax bill. in capital. Also, before committing to any transaction, be sure to speak to a professional who knows your overall situation and can best advise you on the right decision.

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