The Risks of Crypto Tax Loss Harvesting
Everything worthwhile in life has some level of risk attached to it. When it comes to tax loss harvesting or writing off some of your crypto stock, that is no different from any other investment.
In an effort to curb runaway inflation, the Federal Reserve has recently implemented tighter restrictions and significantly increased interest rates. As with most other financial markets, the cryptocurrency market has been hurt by rising interest rates and a deteriorating economic climate.
For the first time since January of 2021, the total market capitalization of all cryptocurrencies is now less than $1 trillion. Prices for Bitcoin and other cryptocurrencies have dropped to their lowest levels since 2020. Since the market is in a bear market right now, it's time to use a strategy like crypto tax-loss harvesting. So, what would be your plan of action?
Okay, so let's begin!
What Does Tax-Loss Harvesting Mean for Cryptocurrency?
Selling cryptocurrency holdings at a loss and using the proceeds to offset gains on other holdings can help you reduce your taxable income. This tax strategy can assist taxpayers in reducing their tax liabilities.
You can reduce your tax liability by selling assets for less than you paid for them using crypto tax-loss harvesting. This is useful if you made any capital gains during the year. Keep in mind that any gains that are cashed out may be subject to taxation. When an asset is sold at a loss, capital losses are realized and can be used to offset or cancel out capital gains.
Cryptocurrency investors frequently use this tax strategy at the end of the fiscal year or after a significant market decline. Crypto tax-loss harvesting, when done correctly, can reduce your taxable income.
Is it legal to claim cryptocurrency tax losses?
It most certainly is! It is entirely legal and does not amount to tax evasion. However, in order to properly use crypto tax-loss harvesting to reduce your income taxes for the year, you must follow certain wash sale rules.
It should be noted that rules like these can differ from one country to the next.
The Crypto Wash Sale Rule
To maximize the benefits of the crypto tax-loss harvesting strategy, you must follow a crypto wash sale rule that varies by country. According to this rule, a taxpayer cannot deduct losses from the sale of a security or stock if the same asset is repurchased within 30 days.
This rule was specifically enacted to prevent taxpayers from selling assets to obtain tax breaks. Assume you made a lot of money this year from your investments. When you examine your holdings, you may discover that you have a large number of unrealized losses.
You could sell the cryptocurrencies in this case to recoup your losses. Then, before the cryptocurrency's value rises, you could repurchase all of these currencies at a lower cost. Because you used a wash sale, your capital losses aren't really losses because you reinvested the proceeds from the sale. Even if the losses are fictitious, you can still use them to lower your tax bill. Many tax offices have wash sale rules in place due to the ease with which crypto tax losses can be harvested. Under these rules, an investor cannot profit from a wash sale.
Is Crypto Tax-Loss Harvesting Limited?
When you examine the tax laws of the United States, the United Kingdom, Canada, and Australia, you will notice that each country has different capital loss limits.
US Capital Loss Cap
A capital loss can be used to completely or partially offset a capital gain in the United States. On the other hand, if your capital losses are larger than your capital gains, you must adhere to specific regulations. Any capital losses above $3,000 can only be used to reduce any capital gains above $3,000. Any losses that aren't used in the current tax year can be carried over to the next.
Canada Capital Loss Cap
The rules for deducting capital losses in Canada are slightly different than those in the United States. However, capital gains are fully deductible, regardless of their size. The law allows you to keep your accumulated losses from one year to the next indefinitely if your annual expenditures exceed your annual receipts.
UK Capital Loss Cap
There is a £12,300 cap on the amount of capital gains tax that any individual can pay in the UK. To the extent that your capital gains exceed your tax exemption, you may deduct the amount by which your capital losses bring them down. The current state of affairs allows for the utilization of unlimited capital losses for the purpose of crypto tax-loss harvesting.
Australia Capital Loss Cap
Capital losses can be used to reduce capital gains if you are an Australian resident. There are no limits on this possibility. Any unused capital losses cannot be carried over to the following tax year. If you have existing capital gains, you cannot offset them by using future losses.
How Does Tax Loss Harvesting in Cryptocurrencies Work?
For all intents and purposes, cryptocurrencies are just like stocks or real estate when it comes to their functionality as a form of capital. Buying, selling, or using cryptocurrency does not result in a gain or loss.
Let's say you invested in cryptocurrency at its peak, and now its value has dropped in half. This is not a loss in cryptocurrency until you sell or trade your coins. Capital gains can be offset by harvesting crypto tax losses, resulting in a lower tax bill. Even if you didn't make any gains on your investments this year, you can still reap the benefits of your labors. Finding additional losses can help you reduce your taxable income or even wipe out gains from stocks or other assets.
You can't, for instance, sell a stock or bond and then immediately buy it back because of wash sale rules. However, in Crypto, this is possible right now. You can theoretically accept a paper loss when selling Bitcoin during a market downturn, trade it for something else, and then trade it back to Bitcoin without losing anything other than the cost of the transaction. With those fees, you effectively throw away thousands of dollars in paper. It is possible, however, that Congress will reverse its previous decision to uphold the now-defunct regulations. Be aware that there is danger here!
The Perks of Taking Tax Losses in Cryptocurrency
The main perk of using a crypto tax loss harvesting strategy is that it helps you pay less in capital gains tax. Depending on where you live, you may be eligible for even more benefits.
For instance, you could potentially drop into a lower tax bracket by deducting some of your capital losses from your taxable income. You could save a lot of money on taxes by switching to a lower tax rate. However, remember that taking advantage of crypto tax-loss harvesting does not ensure you will never have to pay capital gains taxes again.
The point of this method is to buy some time before having to pay these taxes. If you can put off paying capital gains taxes, you'll have more available funds each year to put toward cryptocurrency purchases. Capital gains can be offset by harvesting crypto tax losses, resulting in a lower tax bill. Even if you didn't make any gains on your investments this year, you can still reap the benefits of your labors. Finding additional losses can help you reduce your taxable income or even wipe out gains from stocks or other assets.
Schedule a free, one-on-one session with one of our tax experts through our affiliate, Vincere Tax.
The Drawbacks and Risks of Crypto Tax-Loss Harvesting
There are some potential drawbacks to this tax strategy, but it has the potential to be very beneficial. If you stay within the bounds of the law concerning wash sales, you shouldn't worry about an audit from the tax department. Fees for buying and selling cryptocurrency can add up quickly if you do so frequently. Depending on the currency exchange, fees can average 4% per transaction. You should include these costs when figuring out how much crypto tax-loss harvesting will reduce your tax bill to ensure you're actually saving money.
As was previously stated, your capital gains will still exist even if you harvest your crypto tax losses. At some point in the future, you'll still have to pay taxes on these gains. You must pay capital gains taxes when you sell back-purchased crypto assets. Your potential return on investment in cryptocurrency may be significantly higher than you initially thought if you take advantage of the recent price drop and buy some now. The size of these gains may nullify any tax benefits you reaped from employing this strategy.
Using Cryptocurrency for Tax Loss Harvesting: A Good Idea?
Tax-loss harvesting for cryptocurrencies is useful during bear markets but should be avoided otherwise. Capital gains taxes can be delayed in this way if you have unrealized losses to offset them. Using this method, you can safeguard your savings even as the market plummets. Since the sale of cryptocurrencies in the United States is not subject to the wash sale regulations, there aren't many roadblocks to implementing this method. Before implementing this strategy, it is highly recommended that you review the aforementioned materials to ensure you don't make any avoidable mistakes.
We hope you have found this information to be helpful! If you have any questions, don't hesitate to get in touch with us. We'd love to have a chat with you.
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Crypto tax-loss harvesting is a fantastic way to reduce your tax liability because it allows you to defer paying capital gains taxes. Now that the market has entered a bear market, it is time to employ tax-loss harvesting strategies for cryptocurrencies.
I hope this information was helpful. If you have any questions, feel free to reach out. I’d be happy to chat with you.
About the Author
As Managing Partner of Vincere Wealth, Josh assists clients in navigating financial challenges and making sound financial decisions. Having someone guide you in making sensible financial decisions today can have a substantial impact on your future financial wellbeing. Josh takes great pride in guiding customers through the complexities of taxes, real estate, businesses, employer stock and international financial planning.
If you're interested in an investment advisory or financial planning relationship, please consider Vincere Wealth Management.
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