Tax-loss harvesting in the US: Cut your tax bill

12 December 2023

Why prioritize this?

Every bear market is a tough time for crypto traders.  The satisfaction of watching your portfolio’s value grow day by day is all but gone.  However, this kind of market presents a unique opportunity to consider the potential benefits of tax loss harvesting and how it could minimize your tax liability.  The 31st of December 2023 is fast approaching, so now is the time to be proactive. 

What is tax loss harvesting?

Essentially, it is an investment strategy.  Using tax loss harvesting, you are paving the way to reduce capital gains.  Consequently, you can lower your tax liability for a given financial year.  We can use an example to illustrate this from an investor’s perspective.  Let’s say you buy 1 ETH for $1500 and 1 Solana for $100.  Suppose ETH and Solana’s market prices change to $1000 and $500, respectively.  You wake up one day, and a crypto news article prompts you to sell your Solana.  Assuming you choose not to tax loss harvest, you pay capital gains tax on the $400 gain.  However, if you sell the ETH and realize a $500 loss, this constitutes a capital loss that can offset the gain realized from Solana.  Why does this matter to you? Since your losses exactly offset your gains, you pay no capital gains tax on the capital gain derived from Solana.

By implication, this reduces what would have been a higher tax liability without harvesting.  Keeping a close eye on your portfolio is crucial.  This is because decisions to dispose of assets in isolation may prevent you from realizing the potential for tax loss harvesting.  

Investors should remember that the wash sale rule only applies to assets that constitute securities.  Therefore, since the government sees these assets as property in the country, the rule does not apply to crypto assets in the US.  Before you let the excitement kick in, remember that there are regular proposals for crypto tax reforms in the Federal Budget.  One of these could allow the wash sale rule to apply to crypto assets in the future.

Investors should remember that the wash sale rule only applies to assets that constitute securities. 

When do you sell it, and how does it work?

To be as effective as possible with tax loss harvesting, you don’t simply want to sell your assets at a loss without considering how they offset capital gains.  There is confusion amongst some traders regarding the realization of gains and losses.  As a crypto trader or hodler, you only realize your profits and losses when you carry out the following:

  • Dispose of crypto in exchange for fiat currency
  • Exchange crypto assets for other crypto assets
  • Use crypto to purchase goods and services
  • Send crypto assets as gifts 

You can implement a tax loss harvesting opportunity by keeping track of your unrealized losses and realized gains.  Based on the performance of your portfolio against the market, you can assess disposals that have generated capital gains and, against this, sell certain assets where you are in a significant loss to offset these gains (especially if you don’t see the assets in a loss recovering anytime soon).  You should consider both your realized gains and unrealized losses since realized losses cannot offset unrealized gains.  

You should keep in mind that the tax year ends on 31 December 2023.  Any realized losses to offset realized capital gains should be made before the end of this date. These can carry over to the following year and potentially save you money.  

To be as effective as possible with tax loss harvesting, you don’t simply want to sell your assets at a loss without considering how they offset capital gains.  

What about assets that are trickier to dispose of?

You possess a bunch of NFTs that are worth little.  Disposing of them before the end of the tax season would generate a loss and could significantly increase tax-loss harvesting potential.  However, you are unable to sell these NFTs.  There is a solution to this problem:  you can allow the sale of NFTs through a site called Unsellable! They buy the NFTs you wish to dispose of for a penny in Ethereum and provide liquidity to help facilitate the sale.  You only need to cover gas fees and a small platform fee.  The process works as follows:  you connect your wallet, select the NFTs you wish to dispose of, and then allow Unsellable access to purchase them.  In the end, you confirm the sale and receive a receipt before you can start realizing losses.  As the blockchain space develops, the probability of more solutions emerging to help traders increases, so be sure to be on the lookout!   

You decide to tax-loss harvest: now what?

If you decide to tax-loss harvest, the losses you generate against your realized gains should be captured as accurately as possible.  We will assist you when you are ready to declare your crypto taxes.  The crypto taxation framework in the US is constantly evolving.  Therefore, strong technical expertise that includes a solid understanding of the blockchain, liquidity & staking pools, ICOs/IDOs, and NFTs is crucial to help deliver high-quality crypto tax reports—partner with us for all on-chain tax and accounting.    

 

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