Here’s how big crypto losses can benefit your taxes

Image source: Getty Images

Crypto investors can benefit from this silver.

Important points

• Tax loss harvesting allows traders to recognize a loss on crypto sold in bear markets.
• Rules for wash sales and carry forward losses are part of tax loss considerations.
• Low crypto markets can result in a taxable loss.

Bitcoin (BTC) has hit its lowest point since 2020, and the rest of the crypto market isn’t doing too well either. But if you’re a crypto investor holding onto a losing coin, it’s not all doom and gloom. On the bright side, you may be able to reduce your tax liability by using a strategy called tax-loss harvesting. To learn what you need to know about tax loss harvesting, read on.

Tax loss harvesting 101

The driving force behind tax-loss harvesting is the idea that an investment loss can also count as a taxable loss. By selling a losing investment, investors can turn their negative return into an immediate tax positive.

Let’s start with a simple example of how tax loss harvesting works. Suppose you bought a crypto coin called ABC near its all-time high of $3,000. Unfortunately, ABC was part of a rye pull scheme and now the crypto coin is worthless. Fortunately, your second investment in XYZ coin paid off and you received $3000 in taxable profit. By selling ABC coins, you can harvest your losses and offset your taxable gains leading to $0 taxable investment income. All it takes is selling at the right time!

When it comes to tax-loss harvesting, not all gains are created equal. Short-term investments are investments held for one year or less, while long-term investments are held for more than one year. Long-term taxable gains are also taxed at a preferential lower rate. When it comes to offsetting gains, short-term losses offset short-term gains and long-term losses offset long-term gains. After that, if you have gains in one category and losses in the other, you must first do the short-term and long-term offset. In addition, any sustained loss can offset other types of taxable income.

Related: Best Cryptocurrency Apps

Wash sale and carry on

Before implementing a tax-loss harvesting strategy, you need to understand a few things. Wash sale rules can undo your entire strategy, while carryforwards can affect your taxes for years to come.

The government does not want investors who make money from losing investments to just immediately buy back in. The wash sale rule prevents exactly that kind of thing from happening. The wash sale rule states that investors who sell investments at a loss cannot accept a taxable loss if they buy back identical investments within a 30-day period before or after the sale. Repurchase on the day of sale is also prohibited. While investors cannot buy identical investments, they can buy the like investments to the assets they sold. So if I sold BTC at a loss in my investment portfolio, buying Grayscale Bitcoin Trust (GBTC) shares, even if they are similar, would not be a disqualifying transaction.

Sometimes what you can’t take with you can. For taxable losses, you can only recognize $3,000 of losses in a given year. But if you have losses that exceed that, you can carry them forward indefinitely to spend another year down the road.

The opportunity strikes

Amid falling markets and weak forecasts, crypto investors have weathered storms in recent months. But in declining markets, opportunities knock in the form of tax losses, and many investors can turn losing investments into a safe tax gain.