Why now might be the time to reap the tax losses on cryptos

This year has been difficult for cryptocurrency investors, like a brutal bear market wiped out around 65% of Bitcoin’s market capitalization. However, every cloud has a silver lining, and this time it comes in the form of crypto tax loss harvesting – a strategy in which investors can sell assets at a loss to offset tax requirements.

Tax loss harvest is a strategy used by investors to reduce their capital gains tax responsibility to the US government. To use this strategy, an investor will sell an investment to a capital loss to take advantage of market timing or for the tax year. The loss can then be used to offset capital gains from other assets that produced a profit or to offset future gains from that same investment or other profitable transactions.

For example, suppose an investor buys a stock and realizes a loss of $5,000 with no further capital gains. This investor could use the loss to offset $3,000 of ordinary income for that tax year and carry forward the remaining $2,000 loss to offset future capital gains or income.

Using tax loss harvesting in crypto

Cryptocurrency investors can use tax loss harvesting in the same way as a stock investor.

If an investor bought $10,000 from a encryption token in April 2022 and held the same investment at $7,000 in December, representing an unrealized loss of 30%. By selling the investment at a loss of $3,000, they could use that $3,000 to offset other taxes due from the year. The loss could also be carried forward to the next tax year.

Capital losses taken in cryptocurrency should not be used solely to harvest crypto assets. Losses can be used to reduce tax payable on other asset classes, such as stocks, obligationsand real estate.

Tax loss harvesting has certain limitations

The tax loss harvest can only be used to offset $3,000 of ordinary income ($1,500 if married and filing separately) after offsetting other investment gains. Since gains and losses are locked in at the end of a tax year, investors must reap their crypto losses by the end of December.

This will work out well in 2022 as the cryptocurrency market continued to hit new lows throughout the year. In December, Bitcoin is still trading just below the $17,000 level after starting the year at $42,000. In a bull market phase, however, it could be a risky strategy to reap losses, especially if the ““wash sale” rule applies to crypto in subsequent years (see below for more information on cryptocurrencies and the application of this regulation).

This Tax Service (IRS) rule prevents a taxpayer from taking a tax deduction for a loss on a security sold in a wash sale, which occurs when an individual sells or trades a security at a loss and, within 30 days before or after that sale , buys the same or a substantially identical stock or security, or acquires a contract or option to do so.

It should also be noted that the actions of companies involved in cryptocurrencies will be be covered by the fictitious sale rule. Be sure to check with a finance, accounting and/or tax advisor if you have questions about the best use of tax collection strategies.

Cryptocurrency and the Wash-Sale Rule

The IRS wash sale rule prevents investors from taking capital losses on their investments and immediately redeeming them as instructed. Similarly, a wash sale also occurs if an individual sells a security and the person’s spouse or a company controlled by the individual purchases an equivalent security during the 61-day waiting period.

However, the IRS specifically states that the wash sale rules apply to securities. Due to a lack of clear regulatory guidelines, cryptocurrencies are classified as property and not securities. This means that the sham sell rule does not currently apply to cryptocurrency trading, so investors could redeem their tokens after a sell.

The essential

Cryptocurrency investors are licking their wounds after battling a year-long bear market. Despite this, many investors are unaware of the tax loss harvesting strategy that can help minimize losses and reduce their tax bill.

Investment losses in crypto can be used to offset capital gains in other asset classes such as stocks. Investors can also use them to offset up to $3,000 per year in ordinary income. Investors wishing to use this strategy must act before the end of the current financial year in December.