Cryptocurrency performances have seen a significant reversal in fortune so far in 2018 from the amazing financial returns they generated in 2017. While we’re crossing our fingers that crypto prices start rising again soon, it might be a great time for you to utilize the tax loss harvesting strategy.
This article explains what you need to know about tax loss harvesting within your crypto portfolio.
What is tax loss harvesting?
Tax loss harvesting is a favorite tax strategy of many investment advisors. In fact, robo-advisors such as Betterment and Wealthfront have recently popularized it with the more mass consumer market.
Tax loss harvesting entails taking advantage of individual losses within a portfolio for tax purposes. Practically speaking, it means selling the position so that the loss can be used to lower your overall tax burden.
If you need a refresher on tax loss harvesting and how it applies to cryptocurrency, start by reading this overview article.
Why is now a good time?
If you haven’t noticed, 2018 has not been a great year for cryptocurrency investments. That means, you might have coins that were purchased at prices higher than they are worth today, meaning that particular lot has an unrecognized loss.
By selling that particular position, you can recognize a loss to use for tax purposes. These losses can offset any other capital gains from that current year, and if you have extra losses, can reduce up to $3,000 of your ordinary income (such as from salary/wages). Any losses beyond those thresholds are then carried forward into the next year and applied to that tax return, so the benefit of these losses is never lost.
But I don’t want to sell my investments?
We haven’t yet told you our favorite part about tax loss harvesting as it relates to cryptocurrencies. Because the IRS considers crypto to be property in the eyes of the tax code, wash sale rules do not apply.
What does that mean? Plainly speaking, it means you can sell your crypto positions then immediately buy them back and still recognize the loss this year. This is very different than the rules that apply to stock investments, where the wash sale rule prevents you from recognizing the loss if you repurchase the stock within 30 days (before or after).
Of course, when you subsequently sell the investment down the road (hopefully after the price has gone way up from here), you will calculate your gain starting with your new lower cost basis. So, effectively, tax loss harvesting pushes taxes off into the future. But that saves you on your taxes now, and gives you flexibility later as there are always other options to lower your tax bill down the road such as giving a portion away to charity.
The one caveat to this is that there is another rule called the economic substance doctrine. This rule essentially says that a transaction could be disallowed for tax purposes if the transaction has no economic purpose other than the tax implications. However, there’s no guidance from the IRS on how long you have to wait between selling and re-purchasing to be in compliance with this rule, and it could be different for an individual who has a history of trading a lot versus someone who seldom trades. Whether it’s an hour, a day, a week, or the full 30 days similar to the wash sale rules is anyone’s guess, so consult with a Visor tax advisor if want to weigh the risks of the economic substance doctrine coming into play.
If you invested in cryptocurrencies in 2017, there’s a chance you might have positions within your crypto portfolio that are trading at a loss.
Now is a great time to review your positions and decide if tax loss harvesting makes sense for your situation. The lack of a wash sale rule gives you a lot more flexibility in your options.
If you need help determining your best course of action, contact a Visor tax advisor to talk through the tax implications.
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