Why Selling Bitcoin at a Loss Can Maximize Your Hodling Potential
In my recent conversations with private clients, the number one question I get is about tax loss harvesting (TLH). TLH is best thought of as purposefully selling an investment you bought that is currently below your purchase price to unlock a capital loss on your taxes.
Because of bitcoin’s regulatory classifications, it’s a unique way to take advantage of tax losses that aren’t possible with stocks! A quick note, the following discussion of the TLH strategy is based solely on US tax laws, and this practice may or may not be possible in other jurisdictions.
Steven Lubka, a CoinDesk columnist, heads Swan Private, Swan Bitcoin’s concierge service for high-net-worth investors. This article is part of Tax week.
Additionally, this does not constitute advice, and be sure to speak with your own CPA [certified public accountant] before making any tax decisions!
In the stock market, if you sell a share and buy back a similar instrument within 30 days, any loss generated from the sale will be reversed, meaning you cannot use the loss to offset other capital gains. This rule also applies in reverse.
This is due to something called the wash sale rule, but the wash sale rule only applies to securities. Bitcoin is classified as “property” under the US Internal Revenue Service (IRS) tax code and is exempt from the wash sale rule.
What this allows you to do is to immediately sell and buy back your bitcoin to lock in tax benefits. This is important because most investors don’t actually want to sell their bitcoin at these prices, they want to keep their bitcoin for a possible recovery.
Selling bitcoin and having to wait over 30 days to buy it back can cause investors to miss out on a significant price increase if done at the wrong time. This is why bitcoin’s tax classifications allow for a unique approach to dealing with unrealized capital losses you may have on your bitcoin position.
See also: US Crypto Tax Guide 2022
During my time leading the Swan Private team for Swan Bitcoin, we have helped investors execute hundreds of tax-loss transactions while keeping prices low, generating very meaningful tax savings.
A capital loss can profit from it
So why should you unlock a capital loss? Capital losses are a versatile tax tool that can help you save a significant amount of money on your EOY [end of year] tax obligations. There are two main ways a capital loss can help you, and one important detail to be aware of.
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A capital loss can be used to offset a corresponding amount of capital gains. These capital gains can include the sale of stock, dividends from investments, sale of real estate, sale of rental property, sale of startup stock, and K-1 distributions. You can offset any amount of capital gains per year, up to the amount of the capital loss. The one limitation is that long-term capital losses can only offset long-term capital gains, while short-term capital losses can offset either long-term or short-term capital gains.
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A capital loss will allow you to offset up to $3,000 of ordinary income per year. Ordinary income measures W-2 income, rental income, 1099 income and other sources.
What happens if you don’t have enough qualified capital gains and ordinary income to use the entire capital loss? You can actually roll forward the course loss to the next year – indefinitely. This means that even if you don’t expect capital gains this year, but know you will have some capital gains in a future year, you can still take advantage of any capital losses this year to reduce future tax events.
At a basic level, all that is required is a sale and buyback of the bitcoin position. However, there are several other considerations to keep in mind.
Choice of accounting method
Bitcoin investors can choose three different accounting treatments for their bitcoin. These are specific ID (HIFO, or highest in, first out), last in first out (LIFO) and first in first out (FIFO). Each of these methods refers to the question of “which” bitcoin was sold when an investor sells BTC.
For example, if someone had bought 1 BTC on two different occasions and they then sell one bitcoin – which bitcoin did they sell? The one they bought for $10,000 or the one they bought for $60,000. You can see that this obviously makes a big difference.
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FIFO: Any bitcoins sold are sold chronologically in the order they were purchased. The first bitcoin bought is the first bitcoin sold. This method is generally best for people who started buying bitcoin when prices were high and continued to buy as they fell.
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LIFO: All bitcoin sold are sold in reverse chronological order. This method is generally best for people who started buying when prices were low and made their last purchase when prices were high.
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Specific ID (HIFO): Select specifically lots that have the highest cost and sell them first. It will usually allow the investor to lock in the maximum possible capital loss regardless of when coins were purchased.
Why Tax Loss Harvest Your Bitcoin?
In general, the reason most people would benefit from doing a TLH transaction is that they have a portion of their total bitcoin that is down more than 20%. Someone sitting on an unrealized capital loss of this magnitude or more, and who expects capital gains at some point in the future, can take advantage of the current low prices to lock in tax benefits for this year, or years to come.
See also: Crypto gains and tax rates 2022 | (February)
Even if you don’t expect much in the way of capital gains at first, the income deduction may also be a reason to carry out a TLH transaction. This is especially relevant for people who plan to hold their bitcoin for a long time, potentially borrowing against the bitcoin in the future rather than selling it.
If your goal is to sell bitcoin quickly for a profit, you will end up resetting your cost basis when you do a TLH transaction which will extract any accrued benefits. However, if you have a longer investment timeline it may be a good idea to lock in losses today.
