Here’s How Big Crypto Losses Can Benefit Your Taxes

Crypto investors can take advantage of this silver lining.

Bitcoin (BTC)has hit its lowest point since 2020, and the rest of the crypto market isn't doing so hot either. But if you're a crypto investor holding onto a coin at a loss, not all is doom and gloom. On the bright side, you may be able to lower your tax liability using a strategy called tax-loss harvesting. To learn what you need to know about tax-loss harvesting, read on.

Tax-loss harvesting 101

The driving force behind tax-loss harvesting is the idea that an investment loss can count as a taxable loss, too. By selling a losing investment, investors can turn their negative returns into an immediate tax positive.

Let's start with a simple example of how tax-loss harvesting works. Assume that you bought a crypto coin called ABC near its all-time high of $3,000. Unfortunately, ABC was part of a rug-pull scheme, and now the crypto coin is worthless. Luckily, your other investment in XYZ coin paid off and you netted $3,000 of taxable gains. By selling ABC coin, you can harvest your losses and offset your taxable gains leading to taxable investment income of $0. All it takes is selling at the right time!

In terms of tax-loss harvesting, not all gains are created equal. Short-term investments are investments held for one year or less, while long-term investments are held for over one year. Long-term taxable gains are taxed at a preferential lower rate, too. When it comes to offsetting gains, short-term losses offset short-term gains and long-term losses offset long-term gains. After that, if you have gains in one category and losses in the other, only then do short-term and long-term offset. Additionally, any persistent losses can offset other types of taxable income.

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Wash sales and carry forwards

Before implementing a tax-loss harvesting strategy, you need to understand a few things. Wash sale rules could negate your entire strategy, while carry forwards could affect your taxes in future years.

The government doesn't want investors cashing in on losing investments only to immediately buy back in. The wash sale rule prevents just that kind of thing from happening. The wash sale rule dictates that investors selling investments at a loss cannot recognize a taxable loss if they repurchase identical investments within a 30-day period before or after the sale. Repurchasing on the day of the sale is likewise prohibited. While investors cannot buy identical investments, they may buy similar investments to the assets which they sold. So, if I sold BTC at a loss in my investment portfolio, buying Grayscale Bitcoin Trust (GBTC) stock, although similar, would not be a disqualifying transaction.

Sometimes what you can't bring, you can carry forward. In the case of taxable losses, you can only recognize $3,000 of losses in a given year. But if you have losses exceeding that, you can carry them forward indefinitely to use in another year down the road.

Opportunity strikes

Amid slumping markets and lackluster forecasts, crypto investors have been weathering storms over the last few months. However, in down markets, opportunity knocks in the form of tax-loss harvesting, and many investors can turn their losing investments into a sure tax win.