Crypto trading can be a painful process. Profits are nice, but losses can add up quickly in such a volatile trading environment. However, there are ways you can reduce the impact of these losses, and that’s where tax loss harvesting comes in.
Let’s take a quick look at what crypto tax loss harvesting is, how it works, and what its drawbacks are.
What is crypto tax loss harvesting?
Crypto tax loss harvesting is a strategy where you sell your crypto assets at a loss with less value at the end of the tax year to reduce your tax burden. This approach helps you maximize your returns by minimizing your tax liability.
How does crypto tax loss harvesting work?
When you make a profit from selling your crypto assets, they are subject to capital gains tax, which means you will need to pay the required tax in your home country. However, if you lose money on the trades (or in total!), you can use this to offset some of your gains and reduce the total amount you will have to pay as tax.
Let’s say you buy a crypto worth $5,000 in the middle of the year, and by the end of the year, the crypto’s value drops to $3,000, which means you have an unrealized loss of 40% of the $2,000 amount. If you sell the crypto at a loss, you can use the $2,000 to offset other taxes for that tax year or the next. You can use capital losses from cryptocurrency to deduct taxes from both cryptocurrency and other assets, including stocks and real estate.
Some crypto tax laws allow you to carry forward losses from one tax year to set off gains from the next tax year. You can do this if you experience a large loss or excess of your gain in the tax year. For example, the United States Internal Revenue Service (IRS) allows crypto investors to carry forward up to $3,000 of their capital losses to offset capital gains in future tax years.
Let’s say you experience losses on a cryptocurrency investment that exceed gains for your current tax year. You can use excess losses by carrying them forward to offset future capital gains. This way, you can reduce your tax liability and save money on taxes in future.
To make the most of crypto tax loss harvesting, you need to record your investment activities and results, i.e. gains and losses, to make it easier to calculate your taxable income and reduce errors and inconsistencies when reporting to the tax agency .
We will briefly explain how cryptocurrency tax loss harvesting works with the following steps so that you can better understand it.
To reduce the tax liability on your capital gains, you must use losses from selling those assets to offset capital gains generated by other investments.
If losses from selling unprofitable crypto assets exceed your realized capital gains, you can carry forward capital losses to offset gains for the next year. This is subject to specific limits permitted by tax regulations in your country or jurisdiction.
4 Disadvantages of Crypto Tax Loss Harvesting
Below are some of the drawbacks of crypto tax loss harvesting.
1. Market Volatility
Crypto market volatility can affect you in two ways when harvesting crypto tax losses. Firstly, crypto prices fluctuate rapidly, which makes it difficult to calculate your profits and losses. Rapid price movements can lead to inaccurate calculations, increasing the likelihood of errors. Furthermore, selling a crypto asset at a loss will make you miss out on any major price increases that may happen soon.
2. Complex process
Crypto tax loss harvesting can be complicated, especially if you have to calculate the value of multiple cryptocurrencies or are unaware of your country’s crypto investment tax implications. In addition, you may find it difficult to track down the necessary records and calculate statistics as needed.
If you cannot calculate your crypto taxes yourself, you may need to enlist the help of an expert or obtain reliable tax filing software. Unfortunately, even though these options make it easier to calculate your taxes, they may require you to pay some additional fees, reducing the overall benefit of the entire process.
3. Changing cryptocurrency regulations
Cryptocurrencies are still new, and the regulations are largely unclear and constantly changing. Therefore, you may need help keeping up with the latest tax laws in your country or jurisdiction.
4. Wash Sale Rules
Generally, wash sale rules prevent investors from claiming losses from the sale of property if they buy the same or similar property within 30 days before and after selling it. Wash sale rules differ slightly from country to country, and you may need to understand how wash sale rules work in your country to know how to approach the tax loss harvesting process.