There’s nothing certain in life except death and taxes. The fact that crypto is a relatively young industry doesn’t mean that regulations aren’t here. In fact, the sector is pretty regulated, especially tax-wise. But did you know that you can save money on crypto taxes?
Crypto tax loss harvesting is a strategy that reduces the amount of taxes you pay by selling assets at a loss. The strategy is highly efficient for reducing the burden of taxes and delaying more costly taxes. Given that we’re in a bear market, and might now get out of one anytime soon, now is the perfect time to learn about tax loss harvesting.
Keep in mind that today’s article specifically targets U.S. crypto tax laws. Each regulatory jurisdiction has its own tax laws and rules for cryptocurrencies. What works for U.S. residents might not work for the rest of the world. So if you’re eager to find out if you’re eligible for crypto tax loss harvesting, I recommend checking out your local digital asset tax laws.
How Do Crypto Taxes Work?
There are two types of taxes in the crypto sector: ordinary income tax and capital gains tax.
Ordinary income tax is what you pay when you receive money via existing assets. This category includes passive income schemes such as lending, yield farming, staking, airdrops, royalties, and more.
Capital gain taxes derive from something different. While ordinary income tax involves events in which you make money, capital gain taxes involve events in which your assets make money. This includes situations where your cryptocurrency gains or loses value.
Investors have to pay capital gains taxes on all their cryptocurrency investments, much like they would do for stocks or real estate. Capital tax gains and losses take place every time you sell, spend, or trade crypto. This essentially means that you haven’t realized any losses if you continue holding onto an asset that has lost value.
What’s the benefit of reporting crypto capital losses? You can receive certain tax benefits, and therefore, reduce the taxes you have to pay on your crypto investments. You can deduct a reasonably large amount of money from your income taxes and also use the losses to offset gains in other capital assets.
Cost basis represents the foundation of capital gains taxes. Cost basis is basically the initial investment you make. If you invest $10,000 and end up with a portfolio worth $12,000 at the end of the year, you remove the cost basis and end up with $2,000. This $2,000 is the capital tax gains that you have to report to the IRS.
What Is Crypto Tax Loss Harvesting?
I explained how paying taxes on your crypto investments works in the previous section. You found out that you figure out your capital gains taxes by deducting the cost basis from your portfolio. This technically means that you only pay taxes on profits, and not the whole investment.
But what happens if you invested and suffered loss? Your portfolio reaches a level below your cost basis, what then? This is where crypto tax loss harvesting steps in.
You can use your losses to offset any taxes you need to pay for other cryptocurrencies or capital assets. Let’s say you had invested $10,000 in Bitcoin and the asset went on to fall 30% before the end of the tax year. If you sell, you can offset up to $3,000 in taxes for other assets on which you’ve made capital gains.
What’s even better is the fact that you can also carry over the tax loss to the next year. As a strategy, crypto tax loss harvesting enables you to save money on crypto taxes by turning those unrealized losses into realized losses. And as long as you close your position and report it as a capital loss, you can always open a new position and stay in crypto.
Benefits of Crypto Tax Loss Harvesting
The great benefit behind crypto tax loss harvesting is that you can use your losses to offset capital gain taxes. Let’s say you’re lucky enough to have invested in Solana and lost quite a bit of money. You can use the loss you’ve suffered by selling Solana and offsetting gains you’ve made in another asset, like Ethereum.
Crypto tax loss harvesting is best used when you have long-term unrealized losses. If you have an asset that you’re holding for two years and still remains under your cost basis, you can freely sell the asset to cover capital gains made in the current year.
Are you holding onto an asset, on which you’ve lost a bunch of money, for several years? That’s great news actually. I recommend taking a stroll through your portfolio and looking for any such asset so that you can cover the taxes you’re going to pay for this year’s capital tax gains. Use your losses to your advantage and remove any tax burdens you have.
Another benefit of crypto tax loss harvesting is that you can also offset ordinary income. Yes, that even includes your yearly salary. If you’ve lost $1,000 on a Dogecoin bet, you can turn that loss into a realized loss and remove a portion of tax burden from your salary. However, do note that this specific action is limited to up to $3,000 per year.
Is Crypto Tax Loss Harvesting Really That Effective?
Crypto tax loss harvesting is a great strategy for reducing the taxes you have to pay on your cryptocurrency investments. The strategy works by creating realized losses, by selling assets on which you’ve lost money, and reporting such losses so that you pay less taxes on assets on which you’ve generated capital gains taxes.
You can use tax loss harvesting once each year. Do keep in mind that you have to report your realized losses by the end of the year so that you can offset your capital gains taxes for the current tax year. But don’t fret! You can always leave crypto tax loss harvesting for the next year. If you’ve lost money in 2022, you can offset taxes in 2023.
Crypto tax loss harvesting is an effective strategy because it’s simple, legal, and it just works. You don’t have to just suffer a loss. Use your loss to your advantage by offsetting capital tax gains elsewhere. You can even reduce regular income taxes, but only for up to $3,000.
Want to learn more about crypto taxes, regulation, and compliance? I recommend reading the following articles: