While there are numerous reasons to own crypto, many who have bought it did so simply in the hope that their investment would appreciate. Because crypto is more volatile than other investment options, this tends to mean that there is an asymmetric upside that could lead to a very profitable selling opportunity. On the other side of the investing coin, this also means that these volatile cryptocurrencies could incur heavy losses.

For those who are considering whether to take profits, it’s helpful to have an idea of how much will need to be allocated to pay capital gains taxes. This can help you determine when—or if—you’ll be selling certain crypto assets within your portfolio.

Equally, 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.

Crypto capital gains basics

If you profitably sell crypto you previously bought, you’re taxed on the difference between your sales price and your initial purchase price. Let’s look at a relatively simply example where a crypto investor purchased a full Bitcoin (BTC) on four separate occasions using U.S. dollars (USD), paying $5,000; $15,000; $25,000; and $50,000; respectively (these examples are merely for simplicity’s sake and don’t incorporate historical BTC pricing data).

They then decided to sell one BTC for the current market price of $25,000. Depending on which BTC they sold, the delta (the difference between the purchase and sales price) would be as follows:

• The first Bitcoin purchased for $5,000 would have $20,000 ($25,000-$5,000)
• The second would have $10,000 ($25,000-$15,000)
• The third would have $0.00 as it was sold at the same price it was bought for
• The fourth would have a loss of $25,000 as it was purchased for $50,000

In this example, you’d owe capital gains taxes if you sold either of the bitcoin that was purchased below the $25,000 sales price. Further, the sale of the BTC purchased at $5,000 would be twice as profitable as the BTC purchased at $15,000. You’d therefore owe twice as much in taxes. If you bought and sold for exactly the same price, this isn’t a taxable event as you’re merely “breaking even.”

In the last BTC sale example, you’re selling for half your purchase price of $50,000. As you’re selling for a loss (and a relatively steep one at that), you don’t owe any taxes; you are only taxed on profitable sales. Considered a capital loss, we’ll address how this relates to your tax liabilities later on.

Capital gains: the “short” and “long” of it

Like investing in the traditional stock market, the tax rate of profitable crypto sales depends on the length of time you have held onto your asset prior to selling it. This is because there is a different rate that rewards investors for holding onto investments longer. Called the long-term capital gains rate, this tax rate is lower than the short-term capital gains rate.

If you owned crypto for less than a year before selling, you’d owe the short-term capital gains rate. If you owned that same crypto for over a year prior to selling, you’d be taxed using the long-term capital gains rate. This is an important consideration as it could significantly affect your tax liabilities. When I said you’d owe twice as much in taxes when profiting by $20,000 instead of $10,000, I left out a few important caveats. Let’s reexamine this example.

• Scenario One: You bought one BTC at $5,000 and later sold it for $25,000. The time of ownership prior to selling was 300 days.
• Scenario Two: You bought one BTC at $5,000 and later sold it for $25,000. The time of ownership prior to selling was 400 days.

In this example, scenario two would be better from an investor’s point of view as it would incur the lower capital gains rate. While a good generalization is that the long-term tax rate is around half as much, the difference between these rates depends on your income.

Crypto sales: how “less is more” is actually true

Let’s look at our example again, this time looking at our same investor looking to sell his one BTC priced at $5,000 for $25,000 (for a net profit of $20,000). Further, he wants to sell it soon as the price has been continually moving downwards and he suspects this trend will continue. At this moment, he has held this Bitcoin for 364 days. Considering this, he decides it is likely in his best interest to wait a few days to sell (even though the price is still dropping).

This is because when he first thought of selling his BTC, he would be paying short-term crypto capital gains. By merely waiting a few days, he will be charged the lower long-term crypto capital gains rate. So even if he sold it for $25,000 instead of something slightly higher a few days earlier (like $25,250), he’d be taking home a much better net profit once the taxes are factored in.

On the other hand, if the price really plunged drastically over those two days (from, say, $25,500 to $5,500) and he still sold one BTC, any tax savings wouldn’t make up for the precipitous BTC price drop. While this is an extreme example, those that are looking to sell around a year later should factor in how this annual timing threshold can affect their profitability.

Your income bracket affects your crypto gains

If you’re familiar with how income taxes vary based on your annual adjusted gross income (AGI), you’ll be familiar with the short-term crypto capital gains rates as they are identical. Separated into seven separate tax rate tranches, short-term capital gains are taxed at 10% for those making less than $11,000 and taxed at 37% for those making over $578,125 (for those that are filing “single”). The intermediary rates are 12%, 22%, 24%, 32%, and 35%.

The long-term capital gains rates are only separated into three categories. Those that make from $44,625 – 492,300 per year are taxed at 15%. Those that make more than that maximum pay a 20% rate and those that make less than that minimum pay no long-term taxes (0%). Again, this is for those filing individually.

In general, those that are married and file jointly need double the income to reach the same tax rates. Those that file as “Head of Household” get slightly higher income allowances for similar incomes. For example, a 12% short-term gains tax is incurred for single filers who earn between $11,001 – 44,725, while a Head of Household filer pays 12% when they earn  $15,701 – 59,850. Those that are married but file separately generally pay the same rate as single filers.

First things first when it comes to selling crypto? Not exactly

There may be different methods you can apply to determine your cost basis such as First-in First-out (FIFO) and specific identification using a Last-in First-out (LIFO) order. The IRS guidance requires FIFO unless a specific identification of the cryptocurrency can be made.

Crypto Tax Calculator allows you to choose the inventory method which best suits your needs, such as FIFO or LIFO. You can use DECRYPT2024 for 20% off all plans with CryptoTaxCalculator.

Specific Identification Method to support LIFO 

According to the guidance issued by the IRS (A39), you can use the Specific ID method to calculate the cost basis of each unit of crypto asset you are disposing of. Specific ID means that when you dispose of your crypto asset, you must document the specific unit’s unique digital identifier such as a private key, public key, and address, or by records showing the transaction information for all units of a specific virtual currency, such as Bitcoin, held in a single account, wallet, or address.you are specifically identifying the exact units you are selling. The information for specific identification must show:

1. The date and time each unit was purchased
2. Your cost basis and fair market value of each unit at the time it was purchased
3. The date and time each unit was sold, exchanged, or otherwise disposed of
4. The fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.

Crypto Tax Calculator tracks all of these elements automatically, allowing you to take advantage of inventory methods other than FIFO. Without using software, you will need to manually record these details for every transaction or use the FIFO method.

If these cryptocurrencies could not be specifically identified using the factors above, the FIFO accounting method would need to be used, and our prospective investor would have to sell the first Bitcoin for a net $20,000 gain. If the Bitcoins can be specifically identified, it’s up to the investor to decide which BTC he wants to sell. In this example, our investor has three choices.

In accounting, this requirement to buy and sell in order is colloquially known as “first in, first out” accounting. If this was a requirement, it would mean that our prospective investor would have to sell for a net $20,000 gain. As there is no requirement that the first BTC purchased must be the first BTC sold, it’s up to the investor to decide which BTC he wants to sell. In this example, our investor has three choices.

1. Pay no taxes but sell for a substantial loss by selling the $50,000 BTC.
2. Pay long-term capital gains (on the $5,000 BTC or $15,000 BTC).
3. Pay no taxes by selling at the same price you bought at ($25,000 BTC).

In this example, there are a variety of considerations.

• Do you want to pay more taxes now so you can pay less later?
• Do you want to pay less in taxes now? But potentially more later?
• Do you want to simply break even and take the money out?
• How much in losses can you harvest on your next tax bill?

While some would recommend the break-even option or selling the $15,000 BTC (for less profit but also a smaller tax bill), it’s ultimately up to you to decide what accounting decision works best for you when you’re filing your annual taxes. This will vary based on your income, the performance of your other investments, your investing time horizon(s), personal needs, and a host of other individual considerations.

Crypto tax software such as Crypto Tax Calculator can help with specifically identifying each individual cryptocurrency so that there is the option to use a more favorable accounting method. If you’re wondering about selling for a loss and the implications of such an action, we’ll be exploring the pros—and cons—of this later in this article.

Crypto-to-crypto trades and crypto purchases aren’t tax exempt

As a reminder, it’s worth reiterating that selling for fiat currency (such as USD) isn’t the only type of crypto transaction that incurs a taxable event. Let’s look at the $5,000 BTC that was purchased by our prospective investor again, which rises to a market price of $25,000. If he used that BTC to purchase another cryptocurrency or stablecoin, that would also incur a taxable event (on the $20,000 price differential).

Further, you can’t fool Uncle Sam and get around crypto taxes by making a direct purchase; any direct purchase with BTC in this scenario would also be a taxable event. If you used one BTC to purchase a car or a luxury watch, that would also be a taxable event. Or, you could use some accounting magic and use your break-even BTC (also at $25,000) to purchase that watch or crypto—tax free.

Crypto capital losses basics

While everyone purchases investments with the belief that they will appreciate in value, no one has a perfect investing record.

Nevertheless, 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 Bitcoin 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 10 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.

Cheat Sheet

• The IRS expects you to pay taxes on profitable crypto sales.
• If you’ve held crypto for less than a year, you’d owe short-term capital gains taxes on any related sales at a higher rate.
• If you’ve held crypto for more than a year, you’d owe long-term capital gains taxes on any related sales at a lower rate.
• Both your short-term and long-term capital gains rates are dependent on your annual income. Those with higher incomes pay a higher tax rate.
• Crypto-to-crypto trades and the direct purchase of goods and services can also be taxable events.
• 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.