Save Money on Crypto Taxes with Tax Loss Harvesting
We’ll have our co-founder Zac McClure on live stream discussing crypto tax loss harvesting. Learn advanced techniques used by skilled investors to reduce your crypto tax liability.
Saturday Oct 12th, 2019 at 3pm EDT
Topics in this webinar will include:
What tax loss harvesting is, and how skilled investors use it to strategically lower their tax liability
Disposing of the right tax lots to keep long term holdings in tact
Using crypto tax loss harvesting to offset gains in other capital assets like stocks and real estate
Zac McClure: A lot of people say, "Hey, I have this EOS that I support the project, I bought it at high prices, but I want to sell it to realize the loss, but how do I reconcile those two positions?" And the thing about tax loss harvesting is that you can sell the EOS, for example, and then you can buy it back. If you sell it and immediately buy it back, it potentially looks like you're doing it only for tax reasons. So we don't advise doing that, but to be clear, nothing has been said about tax-loss harvesting by the IRS. And nothing has been said about wash sale trading. And the reason why you don't want to sell and buy back immediately like for stocks, for example, if you did this with Google shares or Tesla shares, and you bought back the position that you had the realized loss on within 30 days, you would forfeit that loss. So basically that's called a wash sale. When you sell something, take a loss and then buy it back within 30 days.
So common sense indicates, "Hey, nothing's been said about crypto, but it's pretty similar to securities where stocks and bonds, where tax-loss harvesting and wash sale rules do apply. And those of you in the UK and Canada have a different situation where you have something called Bed and Breakfast thing, which is very similar to wash sale trading and in those countries, it is specifically not allowed. There are specific rules around harvesting a loss and then buying back the same position.
So a few things you could do to avoid that, if you're selling a lot of different cryptocurrencies, the problem is a lot of Altcoins you have to sell for Ethereum. So you could sell the Altcoins, harvest those losses and then at the end, you figure out which Ethereum tax lots you want to sell. You don't want to sell the ones you just bought, you want to sell the ones that you've held at a loss. So let me show you what this means in principle.
Okay. So a couple of common questions, wash sale rules we just got into that. If anyone has any questions, Alex, will you let me know if anyone asks a question? And then a lot of people- In your tax loss harvest or in your token tax account, you're able to see your tax dashboard. Let me share my screen. So you can see here... alright.
In this demo account, the user has $22,000 in short term gain, $82,000 in a long term loss. So they might be thinking, "Hey, I already have enough losses for this year. All I can take are $3,000 of losses against ordinary income. Why would I harvest more losses?" And what I would say to that is it's true it won't affect your 2019 taxes, but these capital losses carry forward forever. So when we were talking about this a year ago, prices were even lower than they were.
Now, a lot of Altcoins have recovered and now the opportunity is gone to actually harvest the losses. So when you have the chance to do it, savvy investors, hedge funds, this is what they do every year with their stock and bond portfolios. They figure out which ones have dropped during the year. They have gains, hopefully, if they're good at what they're doing, and then they sell enough of those unrealized losses so that they can get to zero, or if you're an individual, up to $3,000 in capital losses. So let me pause there, see if there are any questions.
"What if coins or tokens are not tradable anymore?" They're not tradable to U.S users. So yeah, this is a very common situation especially with low volume, low liquidity coins. So a couple of things you can do. One, do an OTC trade. An Over-The-Counter trade. Find a counter-party, there are groups in Reddit, I advise that it's not a family member and not like your brother, not like your parents or whatever, because the IRS will look at it like, "Hey, if you're able to reverse the transaction if you exert influence Over-The-Counter party than it is in an arm’s-length deal and the loss will be disallowed."
So for this reason, we've helped out a couple of our clients by, basically, they hold Altcoins that are essentially worthless, and we let them pay part of their tax bill. If they sign up with TokenTax for VIP or whatever, they'll pay 1400 in dollars and then $100 with random Altcoin. So then it will be booked as like a sale of $100, cost basis $12,000, and capital loss 11,900, but we'll make sure you actually transfer the crypto away so that it's very clear to the IRS that it's an arm's-length transaction and you can't reverse it because that's the key. But you can go ahead and find counter-parties on your own. If you know people in projects that are collecting coins or whatever. We've been talking about this about our chain and a couple other sort of "zombie projects" no one knows if they'll become anything, but there are some people buying up big tranches of it potentially for future opportunity to work with the company, partner with the company, lobby the company, et cetera.
If you have an individual situation, go ahead and come to tokentax.co, you can message us on intercom on the bottom right of the screen with your specific situation. We can help you either find an exchange or a place with liquidity for you to sell it. Or figure out some other solution. And again, you still have before December 31st at midnight, so it's not super urgent, but obviously, with the holidays coming up, trading volumes could be even lower and it could be harder to figure this out.
Let me show a tool that we built at TokenTax. A couple of years ago, we were first doing tax-loss harvesting, we just did it in spreadsheets and it was just...
Alright. Here's how many of each crypto you own, here's how many you hold at a gain, here's how many you hold at a loss. For example, you have 2.83 Bitcoin that you hold at a gain and 0.5 that you hold at a loss of 7,000. Normally when you're looking at this, somebody would have a really hard time figuring out how much they hold and at what cost basis and so this essentially bifurcates it. And we were able to do that for our VIP customers - do these special sessions, take their data, build them a pivot table, layout a trading strategy - but we wanted to democratize access to this and give it to all of our users if we could. So the engineers, shout out to the team, put this together, and built a tax-loss harvesting dashboard.
So this is included with even premium packages, our automated software packages and so you can come here and see. For example, this user has 5.51 Bitcoin they hold it at a gain and an unrealized gain of about 15,000, but let's see how much Bitcoin they hold at a loss 4.3.
So this is a perfect situation where the user has five and a half Bitcoin, but with our minimization algorithm tracking the tax lots which the IRS, by the way, said using specific identification, which is like our minimization algorithm, FIFO, LIFO, they're all examples of specific identification, which if you've joined other webinars, you are familiar with us talking about that, but if you have more questions, feel free to come and ask us.
We can track the tax lots to the point where we say, "You want to sell these exact 4.3 Bitcoin and then you'll get an additional loss of $10,440 if you sell them at the current price of just under 7,000 per Bitcoin." For example, and this updates relatively in real-time. Let me pause there and see what else.
Thanks, Frank, for the shout out.
Alright. "Can married couples take 6k in loss?" Yes. It's capped for individuals at 3k and for married couples, one of those weird things. And again, thanks for the comment about the minimization and FIFO, LIFO. So just to give people a brief recap, FIFO, "first-in, first-out" it orders all of your purchases of crypto in date order, sells the oldest one first. LIFO does the same thing but sells the most recent purchase first. Minimization is in our patent pended algorithm that figures out your tax rates for longterm and short term gains and figures out the optimal optimized order that you should sell them in.
If somebody ever tells you you can do FIFO for tax-loss harvesting, they don't really understand what they're saying, because unless you are in a lucky coincidental situation where it just so happens that all your highest price purchases are also the oldest ones. In general, you'll need to do a custom specific identification order to sell the crypto that minimizes taxes to sell the tax lots that minimize taxes. And our algorithm can show you exactly which one those are, where they're held, everything like that. So yeah, this is a good example from a 60,000 net loss to a $95,000 net loss by using minimization throughout 2019. And a lot of our users sign up for 2019, now coming up they'll sign up for 2020 for their tax software, but the awesome thing about that is that you can trade and track all your tax lots and track your gains and losses in real-time. So your software isn't just like TurboTax, where you use it at tax time at the end of the year, you can use it throughout the year for tracking your gains and losses, tracking your portfolio and also for just getting running questions by us. "Hey, what happens if I sell this? Hey, can you look at my account? I made some trades. I want to make sure I don't have any wash sale risks or things like that." And again, It's not clear if wash sales apply. Some people are on crypto Twitter saying, "Hey wash sales absolutely don't apply cryptocurrencies are property." We definitely don't... I wouldn't go that far. I think, again, use common sense.
And the beautiful thing is that let's say going back to my example about the EOS, if you sell the EOS lock in that loss, you could buy a cryptocurrency strongly correlated with EOS. And we have data about the correlations between cryptocurrencies, but essentially most Altcoins are strongly correlated and most Altcoins are strongly correlated with Ethereum. So selling your EOS, locking in the loss, and buying Ethereum is a pretty safe bet for those of you who don't want to get really in the weeds about correlations of different cryptocurrencies. But for those of you who are more interested in the specific nuance, we could talk about Lumens and Ripple being strongly correlated. A couple other common ones. Interestingly, EOS and Tron are pretty strongly correlated.
All right. Let's take a look. Okay. So here's an example. Sara, 35 years old lives in California, has $100, 000 in short term gains this year. So she's paying 45k in taxes. Now, in her portfolio, just like the dashboard we were looking at, you just go up here, tax-loss harvesting, 4.3 Bitcoin, 5.51 Bitcoin that's 9.8 Bitcoin. Here, she's got 7 Bitcoin, but some are held at a gain, some are held at a loss. When she's looking on her portfolio tracker or whatever, it's really hard to see. She knows that she put in 80,000 total it's worth 70,000 now, but which ones should she sell?
And so this is exactly what our tax-loss harvesting dashboard does. It shows you, "Hey, which of this 7 Bitcoin do you hold at, and at what price do you hold them?" So she holds 4.2 Bitcoin at a loss. So she could sell those Bitcoin at a loss of 70,000 and then hold on to 2.8 Bitcoins she bought a long time ago that are at a gain of 60,000.
Now, this gets more complicated as you get into the longterm and short term nuances, which we do. We can do a custom session for that, but essentially short term gains and short term losses are netted out and then longterm gains and longterm losses are netted out. And then if there's a difference, if there's a positive longterm gain and a negative short term loss, then those two are netted out.
So we like to say the Holy Grail is taking a longterm loss, which is tax at a lower rate and using it to block out a short term capital gain. So a lot of people are sitting here, "Hey, I've got 80,000 in losses. What am I ever going to do with that?" Well, for one, it rolls forward forever, so you use up $3,000 per year. And then after that, going into next year, you'll have a $77,000 tax-loss harvesting shield that you can use to go after short term opportunities. For example, you might say, "Hey, I really like the idea of Tezos. I think staking is going to be hot. You buy some Tezos in January, it rockets up it doubles at the beginning of the year and you decide, "Well, I really loved it, whatever price." Now it's twice as high, I don't know if I feel as confident about it. You can sell it, lock in the gain, but you have this shield. So normally you'd be getting taxed at 45, 50% for short term capital gains depending on where you live, depending on your income level. Now that's shielded for you.
There's a lot of creative interesting things you can do. And again, capital losses go across all asset classes. So if you have losses in crypto, you can use it to offset gains in stocks or on a home or vice versa. If you lost money in stocks, which I know has been hard to do with the market going straight up for the 11th year in a row. As we keep seeing tweets about how it's at a record high. But if you have gains in your stocks, you can use losses in crypto to cancel it out or vice versa.
And again, you might've made money overall in crypto, made money overall in stocks, but the amazing thing about tax loss harvesting is we can cherry-pick any bad investments or any investments that are upside down right now and use them to shield taxes.
Okay. Interesting question from Mondo. "Let's say you were paid in crypto." Yeah, this is a great example and people have a lot of issues with this when it comes to mining, getting paid in crypto for certain projects, especially if they are illiquid.
Let's say you got paid $100,000 XYZ token, now it's worth $10,000. Well, that 100k what it was worth when you got it, you have to report as ordinary income. So if you're a contractor on that project, you owe taxes on that as if you got paid 100k from a job. But in fact, if you're 1099, you're self-employed, so you owe FICA taxes on that. So 15.3% social security and FICA tax, plus ordinary income taxes to your federal and state. But if you sell it today, you have a $90,000 loss. Now the crazy thing is that loss doesn't cancel out the 100k. Cause capital losses don't cancel out ordinary income, just like they don't cancel out mining income which is why so many people found themselves in such a disaster. And capital losses also do not carry it backwards.
So, what you can do in this situation is one, learn from your mistakes. Understand that when you receive that much crypto and it's worth a 100k, try to sell it quickly, sell enough at least to pay your tax burden so that you don't end up now owing 40k in taxes when the crypto you had is only worth 10k.
Another thing that you can do is hire an accountant, get an accountant that can help you argue that it wasn't worth 100k when you got it because let's just say, okay, I Google coin market cap said it was worth a dollar a token. I got 100,000 tokens, that doesn't mean you actually could have sold all of them that day. If you had sold them, you would have crashed the market for example, and we can help you make that argument and say, "Actually, it was only worth 30k because of the liquidity issues, the market value, the market price is not accurate. And so this is something we do for a lot of our clients who get paid in crypto or people who have mined crypto. A lot of marketing companies got paid in tokens of projects where the value was way higher, that the value they put on the token when they paid someone was way higher than what they ever could have gotten on the open market. And so because of that, you have to give it a haircut, but it's a subjective situation based on a number of factors. Were you allowed to sell it? What was the daily liquidity? What was the daily volume? It's kind of difficult to figure out, but we're happy to talk about that situation if you find yourself there. But again, if you're mining crypto, if you're getting paid in crypto, really good rule of thumb is to sell part of it when you get it to pay the taxes just for treasury management.
I know people want to be along their projects and along crypto, but it's just ..Sensible treasury management. That's why so many of these ICOs blew up, they raised a ton of money in Ethereum when Ethereum was at $1000 per Eth and then when it dropped 80, 90%, five years of runway goes to six months, goes to five months of runway. And so the projects basically turned into zombie projects, they couldn't pay their developers, couldn't pay their teams. So, metaphorically speaking that could happen to you as well.
So just to finish up this tax-loss harvesting scenario. Now, Pam or Sara could have sold all 7 Bitcoin. Would have been a $10,000 loss, would have shielded 4,500 of her taxes, but instead, she can customize exactly what Bitcoin she's going to sell. Sell the 4.2 she held at an unrealized loss, now she saved herself 31,500 on her taxes.
So you can buy these back especially with Bitcoin and Ethereum, which are like the cryptocurrencies and Binance coin that are often used to trade for other cryptocurrencies. I feel like there'll be specifically sympathetic. The IRS will be sympathetic about wash sale trades there, but better safe than sorry. If you can wait 30 days or buy a correlated cryptocurrency in the meantime, or like a basket of cryptocurrencies like Grayscale has a new trust product. They're the makers of GBTC. You could buy their new trust product that is 80% weighted in Bitcoin. Sell your Bitcoin, harvest the losses, buy another product you still have 80% exposure, but it's a basket of cryptocurrencies it's a totally different security. And then hold that as long as you need to and then you can reinvest in Bitcoin later. And after 30 days, you have absolutely nothing to worry about. Even with stocks and even with securities where wash sale trading is prohibited.
Okay. Let's go back. As you can see, we can come here sort out the losses, sort it in order of unrealized losses and just go down the list. Hey, if you hold gas, do you want to hold that you could reap $11,000 in tax savings in unrealized losses by selling it? And so if you're confused about where to start with tax-loss harvesting, this is what I suggest.
Make sure all your data's in your 2019 TokenTax account. Ask us if you have any issues, make sure all the- It should happen automatically if you only traded on major exchanges. If you add any ICO purchases (Initial Coin Offering) we can help you get that in properly, but you could just use our automated tool as well for entering those traits. And just go down the list here and sell the positions that you don't want to hold anymore that are at unrealized losses and just be careful not to sell too much.
In this demo account, if I sell 5 Bitcoin, well 0.7 of that is going to have a gain. And of course, our minimization algorithm can help you sell the 0.7 Bitcoin with a smallest gain, but you're still going to be increasing your taxes. But this situation is interesting because, with this dataset, you're looking at, like we said, a $96,000 loss already. So even if I don't want to sell any of these unrealized losses, I can come down here and say, "Alright, 23,000 of gains, I could actually sell any of these and not pay any taxes." My taxes are shield on basically the next 95,000 of gains I have. So if the user had like a big $80,000 short term capital gain on some cryptocurrency that had rocketed up, they could harvest it right here, not owe any taxes.
I know a lot of you were at Lyft, Uber, no longer we work, I guess. That's tough one on that one, but Dropbox places like that. If you have major capital gains from your RSUs or from your stock options from your company going public this year, this is a really good way that you can figure out, "Hey, how much of my losses can I sell? Or how much of my gains can I shield with crypto losses?" And we can help you figure out exactly how much you owe.
Here's just an example of Lyft IPO. Hey, based on these grants, these RSUs, these options, we've helped figure out exactly how many can be sold without triggering any additional gains. And we can figure out whatever state you're in if you're moving States, does it make sense to have more gains now, more gains in the future? Are you moving to a lower tax state? Are you moving to Washington? Are you leaving the U.S for residency? We get a lot of questions like this. And our accountant team can help answer any of them.
Okay. Frank, "I would hold on to Rchain." Yeah. We could have a long discussion about Rchain, we'll have an offline. If you want to know more about correlations, we wrote a research piece about it that Barrett published that we could share. Just come on our site and we can show you, but essentially almost all Altcoins are like 90% correlated or more, which kind of makes sense given the volatility of the market and how they move together.
Alright. So that's tax-loss harvesting in a nutshell. Unless there are more questions, I didn't have too many other things but feel free to come again tokentax.co, chat with us on intercom you can see it right here. We're always around to answer your questions within a few minutes, we love seeing familiar faces when customers come back.
And again, this is one of the biggest reasons why we encourage people to buy 2019 account with us, during the year, so they can leverage the tax-loss harvesting tools all year and especially this month before the end of the year. And you know, it's going to be the same argument next year when you're doing your 2019 taxes. Please help us out purchase your subscription early, and we'll be happy to make it worth your while throughout the year. We're always adding new features, new functionality.