Reporting bitcoin and cryptocurrency capital gains on your yearly taxes isn’t always at the top of everyone’s priority list. However, there is a bright spot in the world of crypto tax reporting: the laws and tax treatment of virtual currency provides you with a tremendous vehicle for tax loss harvesting, or in other words, a way to heavily reduce your tax liability.
How are cryptocurrency gains and losses taxed?
In most countries, cryptocurrencies are treated as property for tax purposes, not as currency. Just like other forms of property—stocks, bonds, real estate—you incur a tax reporting requirement when you sell, trade, or otherwise dispose of your cryptocurrency for more or less than you acquired it for.
In this sense, cryptocurrency trading looks similar to trading stocks for tax purposes.
For example, if you purchased 0.1 Bitcoin for $1,000 in June of 2018 and then sold it two months later for $2,000, you have a $1,000 capital gain. You report this gain on your tax return, and depending on what tax bracket you fall under, you pay a certain percentage of tax on the gain. Rates fluctuate based on your tax bracket as well as depending on whether it was a short term vs. a long term gain. This applies for all cryptocurrencies.
Tax loss harvesting 101
So we’ve established that cryptocurrencies are treated as property for tax purposes. This means that you can leverage tax loss harvesting strategies to strategically reduce your capital gains and taxable income—just like professional tax planners do with other forms of property like stocks.
Simply put, tax loss harvesting is the practice of selling a capital asset at a loss to offset a capital gains tax liability. By realizing or “harvesting” a loss, investors are able to offset taxes on both gains and income.
Greg buys $1,000 of BTC and $2,000 of ETH in a given year. While holding these investments, the value of Greg’s BTC rises to $1,500 while ETH drops to $1,700. John sells all of his BTC for $1,500.
Without Tax Loss Harvesting
Without harvesting his losses in ETH, Greg has a $500 capital gain for the year from the sale of his BTC. Greg pays taxes on all $500 of this capital gain.
With Tax Loss Harvesting
Rather than continuing to hold his ETH and wait for it to go up, Greg can harvest his losses in ETH by selling before year-end. Capital gains and losses get summed together for the year resulting in either a net gain or loss. Greg’s net capital gain is now only $200 for the year ($500 – $300). In this scenario, Greg only pays taxes on $200 of net capital gains rather than $500.
Given the fluctuating price of most cryptocurrency assets, many traders have enormous tax loss harvesting opportunities that go completely unnoticed and unused year after year. Crypto tax calculators can help identify which assets in your portfolio have the largest “unrealized” losses for you to harvest prior to Dec 31st.
Net capital losses up to $3,000 reduce your taxable income
Whenever your total capital gains and losses for the year add up to a negative number, you incur a net capital loss. If the net capital loss is less than or equal to $3,000 ($1,500 if you are married and filing a separate tax return), then that entire capital loss can be used to offset other types of income—like the income from your job.
If your losses exceed $3,000, then the amount over $3,000 will be rolled forward to the next tax year.
It’s very important to note that before being used to offset other types of income, capital losses offset other types of capital gains. Again, this can provide huge tax benefits for people who have capital gains in other areas or in other cryptocurrency assets.
Time is of the essence
It is important to keep in mind that the tax year ends on Dec. 31st—even though the filing deadline isn’t until April 15th in the U.S. This means that you must harvest your losses prior to the end of the year if you want them to impact that year’s taxes. Many investors delay only to realize that they could have saved money on their tax bill if they would have sold or realized losses back in December. By then it’s too late.
Before sitting down to report your cryptocurrency taxes, make sure you take into account all of your potential tax loss harvesting opportunities. I have personally seen dozens of traders reduce their tax liability by tens of thousands of dollars simply by leveraging tax loss harvesting strategies and strategically trading certain cryptos.