Tax-loss harvesting is a commonly used strategy that can help cryptocurrency traders minimize taxes that they may owe on capital gains, or possibly even increase an investor’s tax refund.
Cryptocurrency provides the unique opportunity of being able to appreciate wealth over time while saving money on taxes along the way by taking advantage of market price fluctuations. It is a common misconception that you should only realize capital losses right before the end of the tax year. Cryptocurrency prices can be volatile and widely fluctuate throughout the year. Wise investors take advantage of the pricing dips throughout the year in order to capture taxable losses at the lowest points during the year.
Imagine if you could appreciate wealth over time while in the process increase your tax refund, or at a minimum reduce what you may owe in taxes. Tax-loss harvesting does exactly that! Tax-loss harvesting is an investment strategy that maximizes after-tax returns by taking advantage of dips in cryptocurrency market prices.
A capital gain or loss is triggered anytime you dispose of (sell/trade) a capital asset. In 2014, the IRS declared cryptocurrency to be a capital asset, meaning that every sale or trade of cryptocurrency results in a capital gain or loss.
A capital gain or loss is equal to the value of what you receive at the time of disposal (commonly referred to as “Proceeds”) less the value of what you obtained the asset for at the time of purchase (commonly referred to as “Cost Basis”).
The following examples illustrate the tax position of two cryptocurrency investors (“Sam”) and (“Rachel”).
Sam purchased .25 BTC for $3,000 in June, Year 1. Sam has no gains or losses yet because he has not recognized a taxable event. Today, Sam continues to hold .25 BTC.
Rachel also purchased .25 BTC for $3,000 in June, Year 1, just like Sam. However, Rachel decided to sell her .25 BTC for $2,000 4-months later in October, Year 1.
In this example, Rachel generated a $1,000 capital loss that she can use to offset other gains or potentially increase her tax refund come Year 1 tax season.
However, Rachel didn’t stop there. Let’s assume that Rachel used the $2,000 proceeds that she received from the sale of her .25 BTC to repurchase .25 BTC. Unlike Sam, Rachel can claim the $1,000 loss on her taxes. Just like Sam, today Rachel continues to hold .25 BTC.
As shown in these two examples, both Sam and Rachel bought the exact same amount of BTC for the same price, only Rachel decided to sell her BTC at the low-point in Year 1 before repurchasing it. By doing this, Rachel was able to take advantage of a tax benefit in Year 1, while Sam was not. This is tax-loss harvesting.
Rachel may realize greater gains in future years when disposing of the .25 BTC because she reset her cost basis. For most investors, it is advantageous to claim capital losses in the earlier years in order to maximize wealth today. As the common adage goes, “money today is better than money tomorrow.”
Rachel could have used the money she generated from her increased tax refund or tax savings in Year 1 to purchase more BTC, while Sam on the other hand left money on the table.
TaxBit’s, ‘Tax-Loss Optimizer’ provides your cost basis and unrealized position in real-time while showing your unrealized losses (by exchange). The displayed unrealized losses are in accordance with IRS requirements (specifically identifying the highest cost basis assets by source). Anytime you have an asset that is “underwater,” (the current value is lower than the value at which you obtained the asset, the optimizer will recommend a tax-loss harvesting trade.
Tax-loss harvesting is a common strategy that wise investors deploy.
TaxBit has made it easy for you to take advantage of tax-loss harvesting throughout the year. Give it a try, today!