Tax Loss Harvesting Strategies – USA

Last Updated: November 2, 2022

Deferring Capital Gains Tax

The idea behind tax loss harvesting is simple – sell positions of assets with unrealized losses to turn those into realized losses, claim the losses on your tax return, offset any short or long-term capital gains tax and minimize your tax bill. While many HODLers may not want to sell any positions, a good investment strategy always includes minimizing and deferring taxes by turning those investment losses into actual tax savings. While it is never fun to talk about taxes, it is key to understand them for good personal finance practices and proper financial planning.

Unrealized Losses to Realized Capital Losses

How exactly does tax loss harvesting work? When you purchase any asset, you have an acquisition cost (cost basis) which is equal to the amount you paid for this asset (plus any brokerage costs or fees). As the market fluctuates, the value of your asset goes up or down, creating an unrealized (paper) gain or loss depending on the direction of the market. For tax purposes, you cannot claim a loss until you sell or exchange the asset with the loss. So if the market isn’t looking too good and you have unrealized losses, if you sell or exchange the assets with the losses, you will then be able to claim the loss! The selling or exchanging of the asset constitutes a taxable disposal, which means that at that point you can recognize your gain or loss for tax purposes – since you had an unrealized loss, by selling, now you can actually claim this loss!

Example 1

  • Elon buys 1 BTC at $55,000 back in November 2021
  • The price of BTC is now at $20,000, meaning his 1 BTC has a $35,000 unrealized loss ($20,000 current price – $55,000 acquisition cost)
  • If Elon sells his BTC at $20,000, he can claim this $35,000 loss in his taxes

Benefits of Tax-Loss Harvesting – Offset Capital Gains!

So if I sell my crypto at a loss, I can claim the loss. How does this help me? 

This helps because you can use these losses to:

  1. Offset short-term capital gains and long-term capital gains
    1. Short-term losses are first netted against short-term gains, and long-term losses are netted against long-term gains 
    2. Net short-term gain or loss and net long-term gain or loss are added together – this means that your short-term losses can offset your long-term gains and vice versa!
  2. If you have an overall capital loss, you can use up to $3,000 per year of these losses to offset ordinary income (salaries and wages & active business taxable income)
    1. Any losses in excess of $3,000 in a year can be carried forward to future tax years indefinitely until used.

Selling your crypto at a loss, generates tax savings when you file your crypto taxes. Remember that this goes by taxable year, meaning that you have until December 31, 2022 to harvest any tax losses and reduce your taxable crypto gains for 2022. Any gains prior to January 1, 2022, you will have to travel back in time to be able to reduce those taxable gains.

Example 2

  • Elon purchased 1 BTC at $3,000 in 2019 and sold it at $35,000 in 2022
    • His gain from the above is $32,000
  • Elon also bought 1 BTC in November 2021 at $55,000
  • The price of BTC is now at $20,000
  • If Elon sells his BTC at $20,000, he can claim this $35,000 loss in his taxes
  • His short-term losses are $35,000
  • His long-term gains are $32,000
  • Elon can combine his gains and losses to get to a net capital loss of $3,000, which he can use to offset his wages from his job
  • If Elon had not sold his BTC purchased in November 2021, he would have had to pay taxes on a $32,000 gain – instead he pays no tax and has a loss!

Example 3

  • Elon purchased 1 BTC at $3,000 in 2019 and sold it at $25,000 in 2022
    • His gain from the above is $22,000
  • Elon also bought 1 BTC in November 2021 at $55,000
  • The price of BTC is now at $20,000
  • If Elon sells his BTC at $20,000, he can claim this $35,000 loss in his taxes
  • His short-term losses are $35,000
  • His long-term gains are $22,000
  • Elon can combine his gains and losses to get to a net capital loss of $13,000, of which he can use $3,000 in the current year against other taxable income, and carry forward $10,000 to use against future capital gains
  • If Elon had not sold his BTC purchased in November 2021, he would have had to pay taxes on a $22,000 gain – instead he pays no tax, has a loss and has losses against future gains!

Offset Other Capital Gains!

What if you have a taxable brokerage account in which you have other gains? Perhaps you have a mutual fund which will pay you capital gain distributions – these are taxable distributions as capital gains that can also be offset by harvesting losses in other assets, such as crypto. You can offset capital gains (and capital gain distributions from mutual funds) from any taxable account with other capital losses from crypto assets. So if one class of investment is outperforming the other, sell your losers, claim your losses and make your tax life easier!

Is This Allowed by the IRS?

Yes – this is one of the best tax breaks for crypto investors! This is a completely legal way of reducing your tax liability which has been used by financial advisors with their clients for many years with equities and other assets. This strategy is not based on a loophole, but rather on tax law, which states that a sale, trade or disposal is a taxable event at which a gain or loss has to be reported. It works both ways though – this is the same reason why everytime you trade one crypto for another (during a bull market), you should plan to set aside tax money….unless you can harvest some losses later in the year.

But what if I miss out?

FOMO is not a reason to not make a smart financial decision. Let’s go back to our examples with Elon – in example 2, if he had not sold his BTC he would have paid tax on a $32k gain. When you consider federal and state taxes, depending on his tax bracket, this could be up to a 30% capital gains tax rate even if it is a long-term gain (when you consider the 3.8% net investment income tax plus state taxes). What is worth more to you? 20% to 30% on $32k($6,400 to $9,600) or making a trade, paying a few fees, and no longer paying the capital gains tax?

To solve the FOMO, there are two strategies we can look at:

  1. Buy everything back shortly after
  2. Plan a smart low-risk rebalancing strategy

Buy everything back shortly after – Wash Sale Rule Risk!

You may ask, can I just sell everything and repurchase immediately? Yes and no….proceed at your own risk. In traditional finance, the Wash Sale Rule forbids traders from doing just that. It basically states that if you buy assets back after selling at a loss, you cannot claim this loss and you instead defer the loss until you sell this repurchased asset. However, as of today, this does not apply to crypto.

If we take a look at the Internal Revenue Code §1091 (which provides the law on wash sales), we see that this law applies specifically to “stocks or securities” and the IRS FAQs clearly state that cryptocurrencies are property. This has created a loophole for crypto traders for the time being. However, this will most likely be closed in the near future. Legislation packages have already had a provision to close this loophole, and while this has yet to pass, it is just a matter of time as the IRS and Congress seek to stop this tax game. Other tax authorities around the world, such as HMRC in the UK, the ATO in Australia and the CRA in Canada have rules to prevent selling at a loss, only to buy back the same assets. This is because most tax authorities around the world do not like it when you have your cake (the tax losses) and eat it too (still have the same positions). So while as of today this rule technically does not apply to crypto, if you want to be extra safe, you should think twice before buying back the same assets within 30 days (or the 30 days prior to selling at a loss).

Plan a smart low-risk rebalancing strategy

A good alternative over buying everything back is having an investing management strategy to:

  • Rebalance your portfolio: as asset prices fluctuate and markets change over time – perhaps you don’t need to buy back your cryptos you sold and instead this is a great opportunity to think of a better asset allocation. Perhaps reinvesting a portion of those gains from the coin that went 100x out of nowhere into other assets to diversify your risk might be a good idea. While this isn’t tax loss harvesting, it’s part of a good investment strategy that can help smoothen out the volatility. 
  • Plan for liquidity needs: it’s never good to have no cash to either pay taxes or take advantage of great dip-buying opportunities. Perhaps once you sell your losing cryptos, you can allocate part of this cash to sit on the sidelines. Sure, this money won’t grow 10x, but if you had sold your losing assets in December 2021 when the markets started to dip and sat on cash then, you would be in an incredible position as of June 2022 to buy back at much better prices.
  • Find correlated cryptos: take advantage of crypto assets that have a correlation in their price movements. Sure, the crypto markets are currently first correlated to the Nasdaq and then to BTC, but even beyond that, you can find coins that have a greater correlation in their price movements than other coins. Perhaps you sold BTC and wish to buy back, but instead of buying BTC you can buy another coin that moves with BTC. Study patterns and price movements (especially during green days) and you will see that there are coins that if you switch to, you can keep similar return / risk profiles. 
  • Find a proxy for the asset: such as Microstrategy (MSTR) Grayscale Bitcoin Trust (GBTC) or a mining company. There are many other assets that move with BTC and buying into those would not impact your ability to deduct your loss. If you sold your ETH, you can look into the Grayscale Ethereum Trust (ETHE). You get the point – find other ways to keep the same exposure. Once the SEC approves a Bitcoin ETF, that will also be a great way for many investors to get direct exposure to BTC.

Remember that it is key to have a good investment strategy and this includes considering the tax implications and having a tax strategy. Don’t just invest without goals in mind as emotions will get in the way when it comes time to take action. A good investment strategy and tax strategy is a must if you want to maximize your funds.

Help with Tax Loss Harvesting

It can be tricky knowing what your unrealized gain or loss is in any specific coin at any point in time. Not only do you have to track the fair market value of that crypto asset, but you have to know the tax basis – this might seem easy in our example with Elon, but what happens when you acquired the crypto from staking / mining or it’s an odd number of coins that has been traded a number of times between different altcoins?

The Trading Tax Optimizer, brought to you by provides you with all the data that you need to identify the unrealized losses in your coins. By connecting your wallets to and classifying all transactions correctly (for the tax basis to be accurately computed), you will be able to use the Trading Tax Optimizer, currently free of charge. Always know the gains or losses in your positions so that you can execute the right trades and minimize your crypto taxes.

Anything Else to Know?

If you have any cryptocurrencies in a crypto IRA or 401k account, this strategy will not work as any trading inside that account is tax-free. However, you might still consider rebalancing or applying other investment strategies previously mentioned.

Investment decisions should not generally start with tax motives, however. Proper tax planning before year-end can help you save thousands of dollars in taxes over the long term.Taxpayers need to understand not only the basic principles, but also how to use software that allows you to take advantage of these opportunities and generate more tax-efficient income – after all, in some countries, you cannot claim losses in your taxes. 

The information presented in this guide is for educational purposes only and is not financial or investment advice. 

The information contained in this guide, including any supplemental materials, is for general information purposes and does not constitute legal or tax advice. In specific individual cases, the present content is not intended as a thorough, in-depth analysis, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. Please consult your tax advisor.

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