What is tax-loss harvesting associated with crypto? Like some other finance topics related to Bitcoin, Ethereum, and other virtual currencies, there are some similarities to traditional financial tools and approaches to investing.
But there are also plenty of grey areas to beware of–what follows is NOT tax advice, but rather an explanation (warning?) of some of the highs and lows of this approach to investing with crypto.
Tax-loss harvesting is not a crypto-specific strategy; it has been used traditionally to offset federal capital gains taxes. Investopedia defines this process as, “the selling of securities at a loss” to do this, typically “to limit the recognition” of short-term capital gains, which Investopedia reminds can be taxed at higher rates than long-term capital gains.
Federal tax laws are subject to review and change at any time; it is a smart idea to review current IRS regulations to see if there are changes that affect your decision or strategy in this area.
We won’t get into an advice-giving situation here. You must review your own financial position, holdings, and potential revenue from your investments to decide if tax loss harvesting is the right approach for you–an experienced financial professional can help you decide. What follows assumes you’ve chosen this approach as it is associated with cryptocurrency.
Tax Loss Harvesting Using Crypto
The cryptocurrency version of the above means you would need to sell cryptocurrency at a loss with the end goal of lowering your capital gains liability. One approach is to do nothing in this area for most of the year until it becomes apparent toward the end before tax time that you may need to take this course of action and lower your capital gains tax.
Why does selling crypto for a loss lower the tax burden on the investor? Because cryptocurrency is not regulated by the IRS as income but rather as property. If the cryptocurrency you hold were recognized as income for tax purposes, this article would read quite differently.
A capital asset like crypto is viewed (by the federal government) the same as real estate or even stock holdings. Stocks are not cash but may be converted into cash. Crypto shares this feature, and hence for now, similar taxation issues.
Crypto Tax Harvesting And Devalued Cryptocurrency
Because crypto is treated as property, it is subject to the same ebb and flow of valuation. Real estate values do not remain constant, nor does the value of cryptocurrency in typical cases. If your real estate goes down in value, have you experienced an actual loss for the purpose of determining your capital gains tax? Not according to the IRS. You only gain or lose value when buying, selling, or trading. Simply holding real estate or crypto and seeing a decline in value is not the same as selling at a loss, at least not for these purposes.
Some people use crypto to do their tax-loss harvesting even if they don’t have any gains with the virtual currency itself. They may be motivated to lower their tax liability for other investments that have no association with Bitcoin, etc.
The important takeaway here is that if you experience gains with your Ethereum investments, say $10,000, but in the meantime, the value of the currency drops far below that, you are still liable for that $10K in gains UNLESS you sell at a loss.
The price you paid and the value you got at transaction time is the dollar amount it’s worth in the eyes of the IRS under current rules. Sell that crypto at a loss and you have just set yourself up to take advantage of these rules…but only if you sell, not if you hold crypto that has lowered in value since you purchased it.
Is Tax-Loss Harvesting Legal?
The IRS allows you to claim these losses where they legitimately exist. However, you may be subject to additional tax liability or scrutiny if you buy back your crypto too quickly after selling it at a loss. There are grey areas related to cryptocurrency–the IRS has not (at press time) taken a position on whether crypto is subject to the same “wash sale” rules as other assets.
At press time, IRS law says you cannot claim a loss if you sell a security or one like it within 30 days after you sold that holding. Is there a 30-day rule that applies in a similar fashion for Bitcoin and other virtual currencies?
The IRS may have to take a position on this issue at some point; in the past there has been legislation proposed that would bring crypto into the same 30-day requirement as other property.
Joe Wallace has covered real estate and financial topics, including crypto and NFTs since 1995. His work has appeared on Veteran.com, The Pentagon Channel, ABC and many print and online publications. Joe is a 13-year veteran of the United States Air Force and a former reporter for Air Force Television News.