The 2023 Essential Guide to Crypto Tax-Loss Harvesting
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Crypto tax-loss harvesting is a strategy in which investors sell assets at a loss during market dips or at the end of the tax year to offset other capital gains, lowering their total tax liability.
You can sell an unlimited amount of assets at a loss, and may be able to deduct up to $3,000 per year to offset ordinary income if your capital losses exceed your capital gains.
Leftover losses can be carried forward into future tax years to offset capital gains or income.
What is tax-loss harvesting?
Crypto tax-loss harvesting involves realizing crypto losses in order to offset your capital gains, thereby lowering your tax burden. Investors typically tax harvest near the end of the year when they can approximate their total gains, or during market dips, when losses are highest.
The same strategy used in tax-loss harvesting crypto applies to digital currency gains or other assets, such as year-end mutual fund payouts.
Additionally, if your capital losses for the year exceed your capital gains, you can use up to $3,000 of losses per year ($1,500 if you are married and filing separately) to offset regular income after reducing investment gains.
In short, crypto tax-loss harvesting can allow you to negate gains and/or offset up to $3,000 of ordinary income for the current tax year or future tax years.
Tax-loss harvesting thus postpones your tax obligations in the same fashion as tax-deferred accounts - it does not cancel any tax obligations. Through tax-loss harvesting, you can use more of the money you currently have to grow your portfolio.
This is how the logic works: By the time you pay the taxes you postponed through tax-loss harvesting, your portfolio would theoretically have generated significantly more than the tax amount you owe. In this scenario, you would end up with a higher dollar amount in the long run.
Everything you need to know about tax-loss harvesting with crypto
How to reduce your crypto tax bill
Crypto is treated as a capital asset, like property or stocks. You only realize a crypto capital gain or loss when you sell it, trade it, or spend it. This means that if you are holding an asset that has lost value, you have not yet realized this crypto loss.
Reporting crypto capital losses on your return has tax benefits. If you have a total capital loss in crypto, you can use that loss to offset gains in other capital assets, like stocks. You could also deduct up to $3,000 from your income taxes.
Otherwise, you can carry forward that capital loss to deduct from future capital gains, whether in crypto or in other asset classes.
This means that you can still benefit from harvesting losses if you don't have capital gains to offset that same year; there is no expiration date on losses you carry forward to offset future gains or income.
Tax harvesting is often used to offset capital gains, but, even if you don’t have gains, you may still want to harvest losses so that you can lower your taxable income or offset gains associated with other asset types.
Read more about how tax-loss harvesting and other strategies can help you survive the 2022-23 crypto winter, and which cryptocurrencies are best to sell for tax-loss harvesting in 2022-23.
Tax-loss harvesting example
You have $5,000 in capital gains for the tax year.
You also have some ETH that is worth $2,500 less than what you paid for it over a year ago.
If you don't sell the ETH you will have $5,000 of taxable gains.
If you harvest your losses and sell the ETH, you will only have $2,500 of capital gains.
When should I tax-loss harvest?
You need to harvest your losses during the tax year. Once the tax year is over, your gains and losses are locked in. Most people elect to harvest their losses in the last month of the tax year. If you’re a U.S. taxpayer reading this near the end of the calendar year, that means it’s time to act now.
Market dips are also popular times to harvest losses, since lower asset prices result in larger losses. Consequently, more gains can be offset.
You can track current crypto prices with CoinGecko.
How much of my losses should I harvest?
There is no limit on the amount of losses you can harvest, so you and your crypto tax advisor can develop a strategy to sell as many assets at a loss as you'd like. For example, you could sell off assets so that you have $0 in capital gains, or you can sell enough so that you have an overall capital loss.
Challenges of tax-loss harvesting
Tax-loss harvesting can be simple for traditional assets like stocks, which likely don’t have many varying cost bases and holding periods.
With crypto, however, it can get a little more complex. For major coins like BTC and ETH, you can have countless different cost bases and holding periods.
How do I handle short- vs. long-term gains when tax-loss harvesting?
Keep in mind that there are different crypto tax rates for long-term and short-term trades; long-term capital gains are taxed at a favorable lower rate in the U.S.
For example, let's say you have unrealized losses in ETH. Some losses are in short-term holdings, and some are in long-term holdings. Your crypto tax advisor may suggest that you harvest losses on the short-term holdings rather than the long-term holdings, so that if ETH prices increase in the future, you will be able to pay the lower long-term capital gains tax rate once you sell it for a profit.
How do I tax-loss harvest NFTs?
In theory, you can tax-loss harvest NFTs just like you would a fungible token. However, the process can come with extra challenges, such as difficulty estimating fair market values or struggling to realize a loss on a worthless asset. For more on this subject, read our Intro to NFT Tax Loss Harvesting.
What if I have unrealized losses and gains for a single cryptocurrency?
If you have unrealized gains and losses for a single cryptocurrency, it's important that you're careful when documenting your tax lots so you don't inadvertently report gains instead of losses.
Tax-loss harvesting with unrealized gains and losses of the same crypto
You bought 1 BTC at $4,000 and 1 BTC at $10,000.
BTC is now trading at $8,000, so you have a $2,000 unrealized loss and a $4,000 unrealized gain. Your total capital gains for the year are $20,000.
You plan to harvest the $2,000 loss. If you sell the right tax lot, you will reduce your capital gains total by $2,000 to $18,000.
However, if you sell the tax lot acquired at $10,000, you will increase your capital gains total by $4,000 to $24,000.
One-on-one sessions with a crypto tax accountant can help you use specific ID accounting to identify the right crypto lots to sell in order to claim the right amount of capital loss.
If you are interested in setting up a session with one of TokenTax’s crypto tax accountants, please reach out to us at [email protected].
Identify and act on tax-loss harvesting opportunities with TokenTax software
With our crypto tax software, you can automatically import all of your crypto data and access your own tax loss harvesting dashboard to find unrealized losses.
TokenTax's tax loss harvesting dashboard automatically identifies unrealized losses in your portfolio, making it easy to find opportunities to reduce your capital gains taxes.
Our tax-loss harvesting tool uses your crypto transaction history to calculate exactly how much of each coin you hold and how much of an unrealized loss or gain you have on each cryptocurrency. This allows you to get a bird's-eye view of your tax-loss harvesting opportunities.
The bonus of tax-loss harvesting with a TokenTax plan is that you’ll have all your data completely imported by the end of the tax year. This means that when it’s time to put together your tax return next year, all you need to do is export your Form 8949 that our software generates for you.
If you would like to speak to our team about the tax loss harvesting dashboard and choosing a plan that is right for you, please contact us at [email protected].
To learn more about TokenTax or to sign up, visit: https://tokentax.co/pricing.
What are the risks of tax-loss harvesting?
Lowering the cost basis
There is risk associated with tax-loss harvesting, even for experienced investors.
One risk is due to the fact that tax-loss harvesting lowers the cost basis of the asset. A capital gain is generated when the sale price of an asset (the amount you sold it for) is higher than the cost basis of that asset (the amount you paid for it). When the cost basis is lowered, the result is a higher capital gain - and a higher capital gain means a higher tax bill.
In a scenario such as this one, you would benefit in the current year from tax loss harvesting, but your savings would be canceled out by the higher taxes you would owe in the future due to a higher capital gain on the asset in question.
Variables such as market fluctuation and changes in personal income or tax rates can affect the taxes you will owe on an asset in the future. However, capital gains - the taxable amount of profit generated from your asset - will inevitably be calculated using the cost basis of the asset. For this reason, tax-loss harvesting could potentially create a loss in the future, even if it saves you money on your tax bill for the current year.
Crypto wash sales
It’s entirely legal to harvest your losses at the end of the year. However, if you buy back your assets immediately, this could constitute a crypto wash sale.
Currently crypto assets are not technically covered by the wash sale rule, which only applies to securities. However, multiple pieces of proposed legislation have aimed to ban crypto wash sales. Although none have been passed, investors should be aware that the issue is on the legislative agenda, and they should check with their crypto tax advisors before engaging in wash sales.
Because of the risk associated with tax-loss harvesting, we always recommend that you consult your CPA before attempting to tax-loss harvest.
Frequently asked questions
Here are answers to some frequently asked questions about crypto tax-loss harvesting.
How much can you tax-loss harvest on crypto?
There is no set limit on the amount of losses you can harvest.
We recommend developing a tax-loss harvesting strategy with your crypto tax advisor to most effectively minimize your tax burden.
Is there a limit to tax-loss harvesting?
There is not a limit in terms of losses you can harvest. However, if you have overall capital losses, there is a limit to the losses you can use to offset ordinary income on your federal taxes.
If your capital losses exceed your capital gains for the year, you can deduct up to $3,000 of these losses to offset regular income. You cannot deduct an amount higher than your capital losses for the year, but additional losses may be carried forward to offset capital gains or income in future tax years.
How often should I harvest my losses?
Due to the volatile nature of cryptocurrency, there are multiple market dips throughout the year when tax-loss harvesting crypto could be advantageous. While many investors wait until the end of the tax year to tax-loss harvest, you can save money and time by using this strategy throughout the year.
What’s the deadline for tax-loss harvesting?
Because your gains and losses are locked in at the end of the tax year, you need to harvest crypto losses by this time. If you are in the U.S., that means that your crypto tax-loss harvesting must be completed by the end of December of the tax year in question.
Should I harvest tax losses crypto?
If you have a total capital loss in crypto, you can use that loss to offset gains in other capital assets, deduct up to $3,000 from your income, or carry that loss forward to deduct from future capital gains in crypto or other asset classes.
Always refer to your CPA for tax-related questions. If you and your CPA agree that you stand to benefit from harvesting crypto losses, tax-loss harvesting would be a strategic and useful move.
Does the wash sale rule apply to cryptocurrency?
Technically no. However, the Biden administration has begun to investigate crypto cases more closely, and it is possible that the loophole that currently allows crypto wash sales will eventually be closed, making crypto wash sales illegal. Further questions or concerns? Our team of experts at TokenTax will be happy to help.
Is tax-loss harvesting a form of tax evasion?
No. Tax-loss harvesting is a legal and widely used strategy to reduce tax liability.
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Last reviewed by Tynisa (Ty) Gaines,EA on March 7, 2023 · Sources