Are you losing big on crypto? How to reduce the sting
Bitcoin, for example, is trading about 65% of its all-time high, which it reached just nine months ago.
If you bought a cryptocurrency when it was on the rise and sold your holdings this year—or are considering doing so—there are at least a couple of ways you might be able to lessen the sting of the loss.
You can use a capital loss in crypto to offset any capital gain you’ve made this year – even if it comes from the sale of another security or property, such as a share or a house.
For example, let’s say you bought bitcoin for $50,000 in February 2021, and recently sold it for $24,000, which is roughly where it’s trading today. You would have a long-term capital loss of $26,000, because you held the investment for at least one year.
Then say you also booked a $10,000 capital gain by selling a long stock in a taxable brokerage account (ie, not a tax-deferred account like a 401(k) or IRA).
You can fully offset the tax owed on your $10,000 capital gain against $10,000 of the capital loss on your 2022 tax return. In addition, you can also use your losses to offset the tax you owe on up to $3,000 of your ordinary income this year.
Whatever losses you don’t use up this year, you can still use in future years. So in the example above, you would use half of your capital losses this year ($13,000) to offset $10,000 in capital gains and $3,000 in income. You can then carry forward the other half of your losses to future years. And if you have a year where you have no gains to offset, you can still use $3,000 of your losses to offset taxes on $3,000 of your income.
But when you die, your losses will die with you for tax purposes. You cannot bequeath them to someone else to use. “Your heirs don’t inherit the losses,” said Larry Pon, a California-based CPA and certified financial planner.
Wash sale rules don’t apply to crypto…yet
Unlike with stocks, you can choose to sell a losing crypto asset to claim the tax loss, but then buy the same asset again around the time of the sale.
Here’s why: For tax purposes, crypto assets are classified as property, not securities. So while you can use capital losses from both types of assets to offset one’s gains, there is a different tax rule that only governs securities and does not apply to crypto assets. At least not yet.
It’s called the wash-sale rule. The IRS will disallow any capital loss you claim on the sale of a stock or security if you buy it back or something “substantially identical” within 30 days before or after the sale.
There is no comparable rule for crypto. “Although the IRS has not specifically addressed the area, most practitioners are of the opinion that the wash sale rules generally do not apply to crypto. The IRS has stated that they treat virtual currency as property, while the wash sale rules apply to crypto. stocks and securities,” said Mark Luscombe, principal federal tax analyst for Wolters Kluwer Tax & Accounting.
So, if you book a loss but still believe that the same crypto-asset holds its promise in the long term, you can buy it back at any time. Even on the same day you sell.
“If you sell [a cryptocurrency] and quickly buy it back, which will enable you to tax loss harvesting without triggering the 30-day rule,” said Kell Canty, CEO of crypto-tax software provider Ledgible.
This trading advantage over securities may not last forever. Lawmakers have already proposed expanding the wash sale rule to cover crypto and other assets in proposed legislation. But the chances of that expansion happening this year are very low.
“This rule may change in the future, but for 2022, crypto assets are not subject to the wash sale rules,” Pon said.
An exception may be if you have indirect exposure to crypto assets, for example through an exchange-traded fund that trades on an exchange, such as the ProShares Bitcoin ETF (BITO).
“Trading on an exchange may allow the IRS to treat such crypto as a security and [therefore] subject to wash sale rules,” Luscombe said.
