One of the big downsides to cryptocurrency is the dizzying price swings that can decimate your investment, but there’s a silver lining to taking a big hit: tax loss harvesting. Due to a quirk in the way the IRS classifies crypto, you can strategically sell your crypto at a loss, repurchase it before the price rebounds, and use the loss to offset capital gains taxes on your other successful investments. Here’s a look at how it works.
Crypto is considered property—unlike stocks or bonds
Since the IRS classifies a cryptocurrency as property, the rules for selling it are a little different. One quirk is that wash sale rules don’t apply to crypto, which means that you can sell and buy back crypto without having to wait 30 days, as is the case with stocks.
This is where crypto investors are at an advantage—without the 30-day rule, they have more flexibility to sell their crypto at a loss, then buy it again before the price ticks back up. The advantage to doing so is that you can use the recorded loss on the sale of your crypto to offset capital gains taxes on other investments, which is known as tax loss harvesting. (Capital gains taxes are triggered any time you cash out an investment, and they can be quite hefty—up to 37% if you sell within a year). Buying the crypto back before the price goes up means you can have the best of both worlds: you’ll be able to write off the loss and still realize the upside if the price jumps way up in the future.
For example, a $50,000 crypto loss would offset $50,000 worth of gains from selling stocks, which means you wouldn’t have to pay taxes on those realized stock gains. The other advantage is that tax loss harvesting can be carried over into future tax years if it’s not used up in a given tax year.
Of course, there are risks
While crypto loss harvesting as described above is considered legitimate by tax professionals, it’s operating in a bit of a grey area, as the IRS has not issued a definitive ruling on the wash sales exemption for crypto. Since the IRS has been cracking down on crypto in other ways, the wash sales rule could change in the near future. Before you make any transactions for tax harvesting purposes, make sure the rules haven’t changed first.
Also, as CFP Jeffrey Levine explains to CNBC, same-day crypto sales carry some risk, as the IRS could still classify them as “sham” transactions that lack “economic substance,” so it’s a good idea to space out the sale and purchase at least a bit. “A day is more than sufficient,” says Levine, “I’d feel comfortable defending that to the IRS.”
Plus, there’s always a risk that you won’t be able to repurchase cryptocurrency at the same price you bought it, even if it’s only a day after you sold it. Crypto is volatile, and has experienced 10% swings within a single day.
And lastly, due to the intricate nature of tax loss harvesting, you’ll need to keep good records of your transactions and seriously consider enlisting the assistance of a tax professional, as they’ll be your best insurance against running afoul of the IRS.
This article was edited after publication to clarify the sentence “For example, a $50,000 crypto loss would offset $50,000 worth of gains from selling stocks, which means you wouldn’t have to pay taxes on those realized stock gains.”