Want help with your crypto taxes? Check out The Decrypt 2023 U.S. Tax Guide. It's free, and there's a fun quiz at the end so you can receive a free Proof-of-Knowledge certificate in the form of an NFT.
While everyone purchases investments with the belief that they will appreciate in value, no one has a perfect investing record. This is particularly true in the crypto investing sector due to its notable volatility when compared to more established asset classes. This has led some early crypto investors to become extremely wealthy.
While these successful investors draw positive attention to this market with viral articles on their investment returns, every market—and trade—has two parties: a winner and a loser. While there aren’t many upsides to “buy high, sell low,” we break down how a crypto investment loss can turn into a partial win through a process called tax-loss harvesting.
The Upside to a Downside: Harvesting Crypto Losses
One upside to seeing your crypto investments in the red (being worth less than your original purchase price) is the ability to sell these investments at a loss in order to harvest capital losses that can be used to offset — or lower — your tax obligations. When an asset is sold for a loss, you can deduct some or all of this loss on your taxes. This is what is referred to as tax-loss harvesting.
The process for claiming crypto capital losses on litecoin (LTC), bitcoin (BTC), and other digital assets is the same process one would use to claim capital losses on stocks, commodities, or other applicable investments. This is why the strategic selling of crypto (or any asset) at a net loss is often utilized by savvy investors and recommended by knowledgeable tax advisors.
Considerations When Harvesting Crypto Losses
One thing to know is that the Internal Revenue Service (IRS) requires you to report all crypto sales. As the IRS considers crypto “property,” these sales must be reported to be properly filing your annual tax returns. It doesn’t matter if these sales are profitable or not; the IRS wants to know about every crypto asset sold. As this is already a reporting requirement, it is in your best interest to understand how these unprofitable sales can be ameliorated through tax-loss harvesting. To be compliant, you are required to fill out Form 8949 and a 1040 Schedule D. You list your crypto sales — both profitable and unprofitable — on Form 8949. The 1040 Schedule D lists both your short-term and long-term capital gains and losses. If you’ve harvested losses from previous years, you also include those losses on this form.
Another key consideration is deciding how you want to harvest these losses. There are two options; you can do this through income tax deductions or via offsetting your capital gains. Offsetting capital gains is relatively simple. You can lower any capital gains taxes by deducting your capital losses to lower your tax bill. For example, let’s say you sold some Tesla stock (TLSA) or BTC for a net gain and some ether (ETH) for a net loss during the same calendar year. You could use your ETH losses to lower your TLSA or BTC capital gains taxes. You would also have the option to offset capital gains in future years if you carried these losses forward.
In some instances, you can also deduct capital losses from your income taxes. If you don’t have capital gains to offset a capital loss, you can deduct this loss from your income to lower your earned income amount and thus lower your income tax obligations. If you do have capital gains offsets, you can’t offset your earned income.
One of the most important things to know when it comes to harvesting crypto losses is that there is an upper limit to the amount you can harvest each year. At the time of writing, the amount you can write off for crypto losses is capped at $3,000 dollars per year. If you lost more than that, these losses can be rolled forward and applied up to the maximum amount until the total loss has been harvested.
Let’s look at a simple example:
Investor XYZ had an annual income of $75,000 and had a bad year of crypto capital losses, also totalling $75,000. This investor also had no capital gains that could be used to offset these losses. This investor couldn’t claim all $75,000 in losses in one year and pay no income taxes — although maybe they wish they could. They would only be able to reduce their earned income to $72,000 to pay taxes on that total. In this scenario, with no other variables changing, they would be able to harvest $3,000 of capital losses for 25 years straight.
Some investors make the decision to take the loss on an investment in order to reduce their capital gains for that tax year. CryptoTaxCalculator offers a tax loss harvesting tool which shows the loss which would be harvested if those assets were disposed of during the tax year, assisting investors to make an informed decision and create a more favorable tax outcome.
How to Treat Crypto Catastrophes, Hacks, and Thefts
You may have lost some — or all — of your crypto investments due to a hack, social engineering scam, or some other theft. According to the current tax code, these losses are treated as investment losses and not casualty losses. Complete losses in these circumstances would be treated as $0.00 proceeds transactions on Form 8949. Let’s look at an example. You purchased ten bitcoin cash (BCH) at $300 per coin for a total of $3,000. Due to a crypto exchange hack, you no longer have access to your BCH. You would be able to claim a loss of $3,000 on your initial investment.
Whether you experienced the hardship of a hack or simply had to sell for a loss, it’s worth understanding how tax-loss harvesting strategies can be utilized to maximize your post-tax investment returns.
Reputable tax software, such as CryptoTaxCalculator, can tag stolen, lost or hacked assets and list them on your tax forms for you.
- Crypto investments sold for a net loss can be used to offset or lower your tax obligations through a process called tax-loss harvesting.
- The process for claiming crypto-related capital losses is the same process one would use to claim capital losses on stocks and other applicable investments.
- You can offset your losses by either offsetting your capital gains or through applicable income tax reductions.
- Annual capital losses are capped at $3,000 per annum. Losses over this annual amount can be rolled forward and applied to future years.
- Crypto lost as the result of a hack, scam, or theft can also be claimed as capital losses and are treated as investment losses.
Disclaimer: This crypto tax series is merely for informational purposes and should not be considered legal or tax advice. Please solicit the services of a crypto knowledgeable certified public accountant, tax professional, or lawyer should you need further guidance.