You don't have to look far to find warnings about the IRS preparing to crack down on taxpayers who fail to declare gains from the crypto world.
With the end of the year approaching fast, for those who do not intend to risk the wrath of the IRS, it is time to get smart about taxes when it comes to crypto.
Tax Loss Harvesting is a practice investors use to get an edge by offsetting tax liabilities from gains with realized losses and then using the tax savings to buy a correlated asset. Let's break that down with a concrete example.
*realized gains or losses refer to gains or losses where you have sold a security for and received dollars
*unrealized gains or losses refer to instances where you have not sold the security to lock in those gains or losses
Also keep in mind that holding crypto for less than a year and then selling for cash qualifies as short term gains (39.6% tax rate), whereas holding crypto for longer than a year qualifies as long term gains (less than 20% tax rate).
So, let's say you invest in the top 6 cryptocurrencies for example (although the same applies for the top 50).
Then when the end of the year rolls around you have:
Crypto A: unrealized gain of $15,000, held for 370 days (long term)
Crypto B: unrealized gain of $10,000, held for 150 days (short term)
Crypto C: unrealized loss of $15,000, held for 37 days (short term)
Crypto D: unrealized loss of $5,000, held for 370 days (long term)
Trading activity:
Crypto E: realized gain of $20,000, held for 370 days (long term)
Crypto F: realized gain of $25,000, held for 180 days (short term)
*Without tax loss harvesting, the investor owes:
($20,000 x 20%) + ($25,000 x 39.6%) = $13,900 in taxes.
*With tax loss harvesting, the investor would sell Crypto C and Crypto D to realize the losses and offset tax liabilities.
[($20,000 - $5,000) x 20%] + [($25,000 -$15,000) x 39.6%] = ($15,000 x 20%) + ($10,000 x 39.6%) = $6,960 owed in taxes.
By harvesting those losses the investor generates a tax savings of $6,940. To properly leverage the tax loss harvesting strategy the investor would then take those tax savings and buy a new top 40 crypto.
*note, you wont gain an edge if you reinvest in one of the coins that you have already held, it must be new to your portfolio!
Good luck!